Your offshore trust should be located in a country that levies no income tax. Nonetheless, being U.S. citizens or residents, you and the (other) Beneficiaries still will be subject to U.S. tax rules. One set of income tax rules about international trusts apply during your lifetime. Different rules will apply after your lifetime.
During Your Lifetime
If your international trust has any Beneficiaries who are U.S. citizens or residents (the usual case), it initially will be classified as a “grantor trust.” This means:
- You must include all the trust’s income, deductions, etc. on your own personal tax return.
- Your dealings with your trust are completely income tax free.
- You can transfer assets to the trust (even if they are highly appreciated) tax free.
- You can receive distributions back from the trust tax free.
- During your lifetime, it’s almost as though, for income tax purposes, your international trust were a simple brokerage account.
Because of the grantor trust rule, the mere structure of the trust has no effect, good or bad, on your personal income tax bill. Instead, during your lifetime, the income tax advantages come from the way the Trustee plans and manages your trust’s investments (assuming you give the investment management job to the Trustee).
For an investor, tax planning means deferring tax bills as long as possible and favoring untaxed appreciation instead of income that is taxed as it’s earned. Most investors do at least a little tax planning. But a qualified a Trustee in certain non-U.S. jurisdictions is likely to be far more effective at it than the average investor, since an alert Trustee has advantages most individuals lack.
That’s why it is important to pick the right Trustee – one with the following qualifications:
- For the Trustee or its adviosers, tax planning is a full-time business. It can devote more attention to the task and budget more resources for the best professional advice.
- The Trustee operates in a zero-tax environment. It is comparatively simple for the Trustee to structure tax-saving transactions between trusts it manages for U.S. clients and other, non-U.S. clients that are not subject to U.S. tax rules.
- The Trustee has ready access to tax-favored investment opportunities that are effectively blacked out in the U.S. by securities laws, insurance regulations and other artificial barriers.
For Your Heirs
After your lifetime, the income tax rules change. Your trust becomes completely foreign. Neither it nor any of the Beneficiaries will be subject to tax on trust income. Wealth will grow faster, because the trust’s earnings can accumulate and compound tax free. This makes a dollar left in an international trust far more valuable to your heirs than a dollar they inherit directly.
Distributions to Beneficiaries after your lifetime are partly taxable and partly tax free. The tax-free portion comes from the assets in your trust at the end of your lifetime. The taxable portion comes from later trust earnings.
In some cases, your heirs can achieve even better tax results by dealing with the trust (buying, selling, borrowing, lending, etc.) than by receiving direct distributions. And in nearly all cases, the Trustee can improve the tax results for Beneficiaries who receive distributions through the way it manages the trust.
or… Start over with Your Own International Trust