Many international Non-Resident Alien (NRA) grantors are establishing South Dakota Foreign Grantor Trusts (FGTs) with South Dakota Trust Company LLC as trustee for foreign beneficiaries and foreign property as well as U.S. beneficiaries and property.
South Dakota is frequently the jurisdiction of choice for NRAs due to the state’s trust protector, directed trust, privacy, tax, asset protection, forced heirship and other modern trust statutes. A South Dakota Foreign Grantor Trust is established as a “foreign” trust for United States tax purposes and therefore is treated the same as an offshore trust, but administered by a U.S. trustee (i.e., South Dakota Trust Company LLC). Typically, the trust qualifies as an FGT if the grantor has the power to revoke the trust or if the grantor or the grantor’s spouse is the sole beneficiary of the trust. Therefore, the FGT may be drafted as revocable or irrevocable, provided that if the trust is drafted as irrevocable, only the grantor or the grantor’s spouse may be named as a beneficiary.
Typically, this is a popular trust for NRAs with foreign beneficiaries and property who are seeking political stability, protection of property, and non-blacklisted countries. The NRA will be treated as owner of the trust under U.S. law if the trust is revocable or if the trust provides for the NRA and their spouse for their lifetimes. Any distributions from the FGT to U.S. beneficiaries will be deemed gifts and not income to the beneficiary. The FGTs can have U.S. as well as foreign beneficiaries. In cases where the trust is drafted as irrevocable, but the grantor has U.S. beneficiaries he or she wishes to distribute gifts to, the trust may make a distribution to the grantor or grantor’s spouse, and then from the grantor or grantor’s spouse to the U.S. beneficiaries. Upon their death, the trusts are distributed outright or in trust to their children, who can be either U.S. citizens or foreign citizens.
Commonly, the NRA establishes a foreign trust in South Dakota with South Dakota Trust Company LLC as trustee to hold shares of the non-United States entity. This entity is utilized to hold both foreign and/or U.S. situs property. If there are no United States situs assets then there are no United States income, gift, and estate taxes. The non-United States entity can also hold United States situs assets producing income, resulting in the 30% withholding taxes or treaty rates to be withheld at the entity level. Both federal and state capital gains are generally saved as well as United States estate taxes with the non-United States entity holding United States situs assets such as publicly traded securities. Alternatively, disregarded domestic LLCs are also utilized for this structure and owned by the Foreign Grantor Trust, but may result in United States estate taxes.
At the death of Grantor, the Foreign Grantor Trust will convert to a Foreign Non-Grantor Trust (“FNGT”). The trust can remain a FNGT and make distributions to the remaining foreign beneficiaries (i.e. spouse, children). Alternatives would be to transfer outright or in trust to children and/or provide the beneficiaries a limited power of appointment so as to provide them flexibility to transfer assets to other vehicles that may be more beneficial for their specific circumstances (e.g., home country law). If the trust coverts to a FNGT and has U.S. beneficiaries, distribution options to avoid the negative tax consequences of the FNGT for the U.S. beneficiaries (for further discussion see below) include: 1.) making distributions of income and realized capital gains annually to avoid accumulated earning issues 2.) distribution to a U.S. Resident Trust 3.) re-domesticate the FNGT to a domestic trust 4.) terminate the FNGT and pour over at death of grantor to a U.S. Dynasty Trust or 5.) provide the beneficiaries a limited power of appointment to distribute.