In the last installment, we began to examine whether a family trust, set up under New Zealand law and in receipt of income from its U.S. limited partnership interest, is required to establish its own EIN or may use an ITIN obtained by the surviving spouse.
Under 26 CFR 301.6109-1(a)(2)(i)(A), the trust is required to obtain an EIN unless (1) it is treated as “owned by one or more persons under IRC 671 through 678,” and (2) it reports its income in a prescribed manner. As discussed in the last installment, these rules allow a domestic grantor trust to continue to be taxed to the surviving spouse even after the death of the grantor spouse.
However, these rules are much less favorable in the case of a foreign trust. Under IRC section 672(f)(1), Sections 671 through 678 generally do not apply to the extent that they would cause trust income to be attributed to non-U.S. taxpayer. In other words, the IRS does not want to see a trust’s U.S.-source income diverted to a non-U.S. taxpayer. But of course, there is an exception: this general denial does not apply to the extent that (1) the grantor has the right to re-claim title to the trust’s assets, or (2) during the lifetime of the grantor, the grantor and/or the grantor’s spouse are the only permissible recipients of trust assets. IRC section 672(f)(2).
So, can our surviving spouse be treated as the grantor? For this, we turn to the definition of “grantor” contained in 26 CFR 1.671-2(e): “[A] grantor includes any person to the extent such person either creates a trust, or directly or indirectly makes a gratuitous transfer (within the meaning of paragraph (e)(2) of this section) of property to a trust…. If a person creates or funds a trust on behalf of another person, both persons are treated as grantors of the trust…. However, a person who creates a trust but makes no gratuitous transfers to the trust is not treated as an owner of any portion of the trust under sections 671 through 677 or 679[.]”
Under the terms of the regulation, someone is a “grantor” only to the extent that he or she made a “gratuitous transfer” of property to the trust. In other words, he or she must have been the beneficial owner of the property under local law prior to the transfer. Even a person who has the right to withdraw trust property is generally not treated as a “grantor” unless he or she actually transferred the property into the trust. If two people transfer property into a trust, each of them will be treated as grantors, but generally only as to the amount they actually contributed. See 26 CFR 1.671-2(e)(6), Examples 4 & 7.
As a practical matter, effect of these rules is to require our New Zealand trust to obtain an EIN unless the surviving spouse can demonstrate that he or she is the grantor of all of the assets of the trust. Because this is a foreign trust, the surviving spouse will not be treated as a substantial owner under Section 678 merely because the he or she has the power to claim the trust’s assets as his or her own property—instead, the surviving spouse must thread the needle of Section 672(f).
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your international tax, tax, estates or business situation, please email him at jcw@eastbaybusinesslawyer.com or call him at 925-217-3255.
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