How to Prevent Taxes on Foreign Trust Income Post-Expatriation

How to Prevent Taxes on Foreign Trust Income Post-Expatriation

Prevent Tax on Foreign Non-Grantor Trust Income Post-Expatriation

The non-grantor trust rules are very complicated and when it involves a US Citizen or Lawful Permanent Resident giving up their US person status – it can get infinitely more complicated. In general, a US Person who expatriates is not subject to an exit tax on the value of a non-grantor trust – since a non-grantor trust presumes he is not the owner of the trust — unless there is an ownership aspect to the foreign non-grantor trust. But, the IRS does not make it that easy or cut and dry. And, what happens when a covered expatriate receives trust distributions from a non-grantor trust post-expatriation? Let’s take a brief look at the process –

Notice 2009-85 (Foreign Non-Grantor Trust)

• • • “Section 877A(f)(4)(B) provides that a covered expatriate shall be treated as having waived any right to claim any reduction under any treaty with the United States in withholding on any distribution to which section 877A(f)(1)(A) applies unless the covered expatriate agrees to such other treatment as the Secretary determines appropriate.”

What Does This Mean?

Section 877A (f)(4)(B) refers to the fact that a Covered Expatriate is treated as having waived any right to reduced withholding.  In addition, section 877(f)(1)(A) requires the trustee to withhold 30% of any taxable portion of the income. The reason this is important is that some tax treaties may reduce or even eliminate withholding of NRA income. But, the Notice does allow the Covered Expatriate a way to possibly avoid this harsh treatment.

• • • “Until further guidance is issued, a covered expatriate may preserve his or her right to claim a treaty benefit with respect to a distribution to which section 877A(f)(1)(A) applies by electing on Form 8854 to be treated as having received the value of his or her interest in the trust as determined for purposes of section 877A, on the day before the expatriation date.”

What Does This Mean?

It means that the Covered Expatriate may be able to preserve their right to claim a treaty benefit by making the election on Form 8854 by electing to be treated as having their portion deemed distribution on the date before expatriation.

• • • “In order to make the election described in the previous paragraph, the covered expatriate must obtain a letter ruling from the IRS as to the value, if ascertainable, of his or her interest in the trust as of the day before the expatriation date by following the procedures set out in Revenue Procedure 2009-4, 2009-1 I.R.B. 118 (or any subsequent publication that replaces Revenue Procedure 2009-4).”

What Does This Mean?

It means that in order to make the election, the covered expatriate must obtain a letter ruling from the IRS as to the value of the trust and the value of the covered expatriate’s interest on the day before expatriation.

• • • “Until the trustee receives a copy of the letter ruling from the covered expatriate and a certification signed under penalties of perjury that the tax due on the value of the interest in the trust has been paid to the IRS, the trustee must withhold as provided in section 877A(f)(1). The amount of tax due on the value of the interest in the nongrantor trust as of the day before the expatriation date will be adjusted by the amount of any tax withheld on or after the expatriation date and prior to receipt of the letter ruling. The covered expatriate may not make the election if the IRS determines that his or her interest in the trust does not have an ascertainable value as of the day before the expatriation date.”

What Does This Mean?

This portion refers to the timing issue. And, until the trustee receives a copy of the letter ruling from the covered expatriate, the trustee must still withhold the 30% tax on the income portion of the distribution.

• • • “If the covered expatriate provides the trustee with a copy of the letter ruling and a certification written under penalties of perjury that the tax due on the value of the interest in the trust has been paid to the IRS, then the tax imposed under section 877A(f) with respect to the trust will be deemed to have been fully satisfied. Accordingly, no subsequent distribution from the trust to the covered expatriate will be subject to 30 percent withholding under section 877A(f)(1)(A), and the covered expatriate will not be precluded by section 877A(f)(4)(B) from claiming treaty benefits with respect to any distribution from the trust under the appropriate article of an applicable treaty.”

What Does This Mean?

Once the trustee receives a copy of the Letter Ruling, and a Certification Letter under penalty of perjury that the tax has been paid, there will be no additional 30% withholding – since now the covered expatriate can claim treaty benefits to reduce or eliminate withholding.

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