Many financial institutions and trust companies in the Cayman Islands serve as the trustee of trusts in which at least one settlor or a current or future beneficiary is a United States person. It is now more important than ever that these trustees fully understand all past, current and future United States federal and state tax payment and reporting obligations related in any way whatsoever to such trusts.
Recent Internal Revenue Service regulatory and
Congressional legislative efforts to better enforce compliance with the tax and
reporting requirements of United States taxpayers with interests in foreign
trusts and other entities, such as the Foreign Account Tax Compliance Act1 and The Offshore Voluntary Disclosure
Initiative2 have highlighted the difficult position in
which a foreign trust company can be placed without proper professional
guidance from a qualified United States tax attorney.
For any trust that
has a United States person, who is the settlor or current or future
beneficiary, and also for any trust that directly or indirectly owns assets
located within the United States, the trustees should take the steps necessary
to determine the following:
- The current and past places of residence, domicile and citizenship for
each settlor and beneficiary, and whether any changes to the current status are
- Whether any settlor or beneficiary ever renounced their United States
citizenship or relinquished their United States green card.
- Whether the trust is considered to be a foreign trust for federal tax
purposes and under what circumstances that may change.
- The extent to which the trust is (and has been) a grantor trust and/or a
non-grantor trust for United States federal income tax purposes.
- Who (if anyone) is current or in the past has been treated as a grantor
of the trust and who (if anyone) is currently or in the past has been treated
as the owner of the assets of the trust and under what circumstances that may
- The United States federal income, estate and gift tax consequences to
the settlor and each beneficiary who is a United States person, whether due to
(a) direct or indirect transfers of property to the trust, (b) powers or rights
in connection with the trust or the entities owned by the trust and/or (c) the
right to potentially benefit from the trust or the direct or indirect actual or
deemed receipt of distributions or loans from the trust.
- The United States federal and state reporting requirements, if any, of
the trustees, the settlor(s) and the beneficiaries of the trust (ie, Internal
Revenue Service Forms 3520, 3520-A, 8621, 5471, 1040, 1041, 8858, 926, 706 and
709, Treasury Department Form TD F 90-22.1 and compliance under FATCA).
- Whether and to what extent the trustee could be held liable for United
States federal withholding tax or federal and state transfer tax (such as
estate tax and gift tax).
- What important changes should be made to the trust deed, letter of
wishes and/or the entities owned by the trust to ensure the trust is structured
in a tax-efficient manner (ie, to ensure there is a “step-up in basis” upon the
death of the settlor, to prevent a United States person from having a “general
power of appointment” for United States federal tax purposes, etc).
- How to administer the entities owned by the trust in a tax efficient
manner (ie, whether and when to make a “check-the-box election” and how to deal
with appreciated assets and retained earnings).
- What type and situs of investment structures should not be held directly
by the trust or indirectly through an entity.
- What procedures should be followed for making any additions to the trust
so as to avoid adverse tax and reporting requirements.
are well advised to conduct proper advance planning and employ institutional
procedures for a systematic review of their trust inventory on a regular basis.
By doing so, the trust company can avoid serious problems before they present
themselves and minimise reputational risks. The benefits of maintaining an
ongoing trust audit policy within the trust company far outweigh the costs
Merely relying upon a representation by a settlor or beneficiary as
to his or her compliance with United States federal and state tax payments and
reporting obligations should not be viewed as sufficient for the comfort of the
trustee. Similarly, the failure of the settlor or beneficiary to comply with
United States law should not be tolerated by the trustee.
Our experience has been that financial institutions and trust companies
have found a systematic trust audit to be a very useful tool to assure
themselves and their clients that their trust inventory has been properly
reviewed and that important United States tax and reporting issues have been
- See http://www.irs.gov/businesses/corporations/article/0,,id=236667,00.html
- See http://www.irs.gov/newsroom/article/0,,id=235695,00.html