US/UK Trusts – Case Study

US/UK Trusts – Case Study

The inclusion of US citizens, green card holders or US residents as trust beneficiaries can have a significant effect on a trust. Trustees have a duty to manage a trust in the best interests of the beneficiaries, but are often unaware of the potentially adverse US tax and regulatory consequences that affect US beneficiaries.

We recently advised the trustees of a trust where one of the beneficiaries moved to the US and became US resident. This resulted in a number of issues that needed to be addressed by the trustees.

The issue

If a trust invests in assets which are classed as passive foreign investment companies (“PFICs”) a US beneficiary may be taxed under US rules on a proportion of the income arising from these investments whether or not that income is then distributed.  PFICs include non-US pooled investment vehicles such as unit trusts and open ended investment companies, partnerships and mutual funds. Trustees are therefore best advised to invest in direct equities or US compliant funds.

The US also imposes rules (known as the “throwback rules”) to discourage trusts from retaining income and gains within the trust. The rules require that any distributions to a US beneficiary are matched against the undistributed income and gains (“UNI”) from previous tax years that have been retained within the trust. The distribution is matched to income and gains from the earliest tax year first. Interest is charged for the period the income and gains were retained within the trust. The beneficiary is taxed at higher rates in the US on distributions subject to the throwback rules. When combined with the interest charge this can mean that the tax and interest owed is equal to 100% of the value of the distribution.

Our solution

We advised that the trustees needed firstly to identify whether any investments were treated as PFICs and then to calculate the UNI within the trust. We sourced a US tax accountant who reviewed the trust and provided this information thereby allowing the trustees to provide the beneficiary with the correct information for his US tax return.

In this particular case, the existing investment managers were not set up to invest in a US tax efficient way and so we also assisted the trustees in finding alternative investment managers who were able to ensure the portfolio would be invested in suitable assets from a US perspective.

We then worked closely with US tax advisers based here in the UK to remove the existing UNI from the trust by way of specific distributions to the US beneficiary.

In order to prevent UNI building up in the future we also worked with a US attorney to create a separate sub-fund for the benefit of the trust’s beneficiaries but excluding all US persons. The creation of the sub-fund is not treated as a new trust for UK tax purposes (thereby avoiding any inheritance tax charge), but is treated as a separate trust for US purposes. As no US persons can benefit from the sub-fund it is not subject to the US tax rules and so can be managed without the need to take into account the US issues outlines above. This solution also ensures that the funds in the main trust can be distributed to the US beneficiary if the trustees decide to do so without being subject to the throw back rules.

This solution is one of several that are available in relation to trusts where either a beneficiary or a trustee is found to be a US person.

For more information please get in touch with James Frampton on