Liechtenstein Anstalt: US Tax Treatment | Foreign Trust Lawyer & Attorney

/in , /by

Over the years, the IRS has made a number of rulings with respect to whether certain foreign entities should be considered trusts for US tax purposes. In this article, I would like to discuss the US tax classification of Liechtenstein Anstalt based on the 2009 IRS Chief Counsel Advice Memorandum, AM 2009-012.

Liechtenstein Anstalt: Creation of the Entity

The word “anstalt” means “establishment”. Any natural and legal person can form an Anstalt. Such a person is called a “Founder”.

A person may form an Anstalt for himself or for another party pursuant to a power of attorney or through a fiduciary arrangement. In most cases, Founders are Liechtenstein attorneys or trust companies that protect the anonymity of the actual owner or beneficiary of the Anstalt.

In order to create an Anstalt, the Founder signs Anstalt’s articles. The legal personality of Anstalt is created once the Founder submits to the government registry its articles, the constitutive declaration, proof that capital has been paid in and evidence that the official registration fees have been paid.

Liechtenstein Anstalt: Founder’s Powers

The Founder has the same powers with respect to an Anstalt that are generally attributed to shareholders in a company. Additionally, the Founder possesses “Founder’s rights”, which provide unlimited control and powers of administration (including the power to dismiss directors, distribute profits and liquidate the Anstalt). The Founder may transfer the rights given to him by law and by the articles, in whole or in part, to one or more assignees or successors. The Founder’s rights may also pass through inheritance.

Liechtenstein Anstalt: Board of Directors

An Anstalt must have a Board of Directors (called a Board of Management or Administration) to represent it in its dealings with third parties. In most cases, the Founder will be a member of the Board. The Founder usually appoints the members of the Board for a term of three years, but may appoint for lesser or longer terms. The Board may consist of one or more natural or legal persons. At least one member of the Board authorized to represent the Anstalt and conduct business on its behalf must have a registered office in Liechtenstein. This member must also be authorized to practice as a lawyer, trustee or auditor, or have other qualifications recognized by the government.

The Board has power with respect to all matters that are not specifically reserved to the Founder. The Founder may give authority to the Board to exercise some or all of the Founder’s rights. The Board may give signatory or agency authority to its own members or to others on behalf of the Anstalt. The Board may assign its management and executive responsibilities partially or completely to one or more of its members or to third persons. In carrying out its management and representation functions, the Board must observe all limitations on its authority contained in the articles in instructions and/or regulations issued by the Founder.

Liechtenstein Anstalt: Beneficiaries and Power of Appointment

The Anstalt’s beneficiaries are those natural or legal persons designated by the Founder, or the person holding the Founder’s rights, as entitled to receive the profits and/or liquidation proceeds of the Anstalt. The right to appoint beneficiaries is usually set forth in the articles and may be reserved to the Founder or granted to the Board or to third persons. If no beneficiaries are appointed, the Founder or his successors are presumed to be the beneficiaries.

Liechtenstein Anstalt: No Shares

The capital of an Anstalt is usually not divided into shares.

Liechtenstein Anstalt: Limited Liability

The liability of an Anstalt is limited to the extent of its assets. No personal liability extends to the Founder, the Anstalt’s Board or the beneficiaries.

Liechtenstein Anstalt: Ability to Conduct Business

Anstalts may hold patents and trademarks, hold interests in other companies and may conduct any type of business except banking. If the articles permit the Anstalt to engage in commercial or industrial activities or a trade, the Anstalt is required to keep proper books and records as well as prepare annual financial statements.

In fact, in most cases, the primary purpose for the establishment of an Anstalt is to conduct an active trade or business and to distribute the income and profits therefrom to the beneficiaries of the Anstalt. The beneficiaries of an Anstalt are usually the previous owners of the business assets contributed to the Anstalt and, in most situations, the Founder acts as a nominee or agent of the beneficiaries in conducting the active trade or business of the Anstalt.

Liechtenstein Anstalt: US Tax Treatment

Based on this description of Liechtenstein Anstalts, the IRS held that a Liechtenstein Anstalt is generally not a trust, but a business entity under Treas. Reg.§301.7701-2(a). This decision would apply in a majority of cases where the primary purpose of a Liechtenstein Anstalt is to actively carry on business activities.

This decision, however, should not be applied automatically to all Liechtenstein Anstalts. Rather, the IRS stated that, in cases where the facts and circumstances indicate that a Liechtenstein Anstalt was created “for the primary purpose of protecting or conserving the property of the Anstalt on behalf of beneficiaries, the Anstalt in such a case may be properly classified as a trust under §301.7701-4.” IRS, Chief Counsel Advice Memorandum, AM 2009-012 – Section 7701 – Definitions. Thus, the critical issue in the analysis of whether a Liechtenstein Anstalt should be treated as a trust is whether it was established primarily to conduct a trade or business or to protect and conserve assets for the designated beneficiaries of the Anstalt.

Moreover, in order for a Liechtenstein Anstalt to qualify for trust classification, all elements of a trust must be present: (1) a grantor, (2) a trustee that has legal title and a legal duty to protect and conserve the assets for the designated beneficiaries, (3) assets, and (4) designated beneficiaries. See Swan v. Commissioner, 24 T.C. 829 (1955), aff’d and rev’d on other grounds, 247 F 2d 144 (2d Cir. 1957).

Contact Sherayzen Law Office for Professional Help Concerning Proper US Tax Classification of a Liechtenstein Anstalt as well as Form 5471 and Form 3520 Compliance

Determining the proper classification of a Liechtenstein Anstalt is very important for its beneficiaries and Founders who are US tax residents, because classification of an Anstalt has a direct impact on these taxpayers’ US international tax compliance, including determining whether Form 3520 or Form 5471 has to be filed. Such determination of US tax treatment of a Liechtenstein Anstalt should be done by an experienced international tax law firm.

This is why, if you are a beneficiary and/or a Founder of a Liechtenstein Anstalt, contact Sherayzen Law Office for professional help with your US tax compliance. We have successfully helped US taxpayers from over 70 countries with their US international tax compliance issues, including classification of foreign business entities and foreign trusts. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

§318 Employee Trust Attribution | Foreign Trust US Tax Law Firm

/in , /by

In a previous article, I explained special §318 rules concerning grantor trusts as an exception to the general §318 trust attribution rules. Today, I will discuss the special §318 employee trust attribution rules as another exception to the general §318 trust attribution rules.

§318 Employee Trust Attribution: Focus on Tax-Exempt Employee Trusts

First of all, it is important to define the type of employee trust which is the subject of today’s article. The focus is on employee trusts described in §401(a) and which are tax-exempt under §501(a), collectively “tax-exempt employee trusts”. In other words, we are discussing mostly trusts which were created under qualified pension, profit-sharing and stock bonus plans.

§318 Employee Trust Attribution: Main Rule – No Attribution to Tax-Exempt Employee Trusts

Under §§318(a)(2)(B)(i) and 318(a)(3)(B)(i), there is no downstream and upstream (respectively) attribution of stock between a tax-exempt employee trust and its beneficiaries. In other words, there is no §318 attribution of corporate stocks from a tax-exempt employee trust to its beneficiaries and there is no §318 attribution of corporate stocks from the beneficiaries to the trust.

Under §501(b), the non-attribution rule applies even in situations where a tax-exempt employee trust is subject to tax on its unrelated business income.

§318 Employee Trust Attribution: Certain Exceptions to Non-Attribution

The non-attribution rule with respect to tax-exempt employee trusts is reasonable and just. There are, however, certain exceptions to this rule.

A major exception concerns ESOP trusts. Under Petersen v. Commissioner, 924 F.3d 1111 (10th Cir. 2019), the non-attribution of stock ownership from tax-exempt trust to employee beneficiaries does not apply to certain ESOP trusts.

Moreover, certain tax-avoidance transactions will render the non-attribution rule inapplicable. For example, under §409(p)(3)(B), an individual is deemed to own stocks held by an ESOP trust for the purposes of determining whether there has been a prohibited allocation of S-corporation stock to a disqualified person.

§318 Employee Trust Attribution: Special Case of “Loss Corporations”

A “loss corporation” presents an interesting set of issues with respect to §318 employee trust attribution rules.

Let’s first define the loss corporation. The IRC §382(k)(1) provides the following definition of a loss corporation: “a corporation that is entitled to use a net operating loss carryover or having a net operating loss for the taxable year in which the ownership change occurs. Such term shall include any corporation entitled to use a carryforward of disallowed interest described in section 381(c)(20). Except to the extent provided in regulations, such term includes any corporation with a net unrealized built-in loss.”

The IRC §382(g) defines “ownership change” as a two-step process. First, there must be an “owner shift”, which means with respect to a 5% shareholder, that there is a change in the respective ownership of stock of a corporation, and such change “affects the percentage of stock of such corporation owned by any person who is a 5-percent shareholder before or after such change.” Second, the ownership change occurs if, immediately after any owner shift, “the percentage of the stock of the loss corporation owned by 1 or more 5-percent shareholders has increased by more than 50 percentage points” over “the lowest percentage of stock of the loss corporation (or any predecessor corporation) owned by such shareholders at any time during the testing period.” Id. The testing period is three years. §382(i).

Now that we know what a loss corporation is, we can analyze its interaction with the §318 employee trust attribution rules. Generally, under §318(a)(2)(B)(i), the participants in a qualified plan under which a tax-exempt employee trust is established are not treated as owners of any shares of a “loss corporation” owned by the trust.

This general rule, however, contains an important exception where the IRS will treat beneficiaries of the tax-exempt employee trust as owners of the loss corporation for certain §382 purposes. See 114 Reg. §1.382-10, T.D. 9269, 71 Fed. Reg. 36,676 (June 28, 2006), applicable to all distributions after June 23, 2006 (for distributions on or before June 23, 2006, see former Reg. §1.382-10T).

Why do we have this exception? The problem is that, by blocking the operation of general §318 trust attribution rules, a distribution of stocks in a loss corporation by the tax-exempt employee trust to the plan beneficiaries may cause an “ownership change” since the beneficiaries are not treated as owners of any interest in a loss corporation. Once the ownership change occurs, §382 may limit the amount of taxable income that can be offset by certain loss carryovers and recognized built-in losses of the loss corporation. Hence, the IRS enacted this exception to §318(a)(2)(B)(i) for certain §382 purposes. This is one of many examples of “an exception to an exception” that saturate the Internal Revenue Code.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

US tax law is incredibly complex (as the discussion of the loss corporation and its interaction with §318 employee trust attribution rules demonstrates); the complexity increases even more at the international level. US taxpayers who deal with US international tax law without the assistance of an experienced international tax lawyer run an enormous risk of violating US tax laws and incurring high IRS penalties.

Sherayzen Law Office is a highly experienced international tax law firm which specializes in US international tax compliance and offshore voluntary disclosures. We have helped hundreds of US taxpayers to successfully resolve their US international tax compliance issues, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

§318 Grantor Trust Attribution | Foreign Trust Tax Lawyer & Attorney

/in , /by

In previous articles, I discussed the §318 downstream and upstream attribution rules; in that context, I also mentioned that there were special rules concerning grantor trusts and tax-exempt employee trusts. This article will cover the special §318 grantor trust attribution rules.

§318 Grantor Trust Attribution: Definition of Grantor Trust

A grantor trust is any trust which, under the IRC §§671–677 and 679, is taxed as if owned in whole or in part by the trust’s creator. This means that the grantor (or “settlor”) must include all items of income, deduction, and credit which are attributable to that portion of the trust property of which he is deemed the owner.

§318 Grantor Trust Attribution: Downstream and Upstream Attribution to Grantors

The grantor trusts are subject to both, upstream and downstream attribution of stocks. Under §318(a)(2)(B)(ii) (downstream attribution), the grantor constructively owns all stocks owned directly or indirectly by the trust. Under §318(a)(3)(B)(ii), the trust constructively owns all stocks owned by the grantor.

§318 Grantor Trust Attribution: Interaction With Other §318 Attribution Rules

Surprisingly, there is no IRS guidance on how the special §318 grantor trust rules interact with other §318 trust attribution rules. At first, it appears that other constructive ownership rules would apply only to beneficiaries of a trust other than the grantor.

This, however, is not at all certain; an opposite conclusion can be reached that the Congress intended the exclusive application of its special grantor trust attribution rules. Hence, in some situations, it would not be a frivolous position for a taxpayer to state that the grantor trust rules of §318 replace all other §318 trust attribution rules with respect to grantor trusts.

§318 Grantor Trust Attribution: Illustration

Let’s illustrate the operation of the §318 grantor trust attribution rules with an example. Here are the hypothetical facts: G, an individual, creates Trust T; under §676, he is treated as owner of Trust T because he reserved the right to revoke the trust; there are two beneficiaries, A and B (nephews of G), who have a 50% vested interest in T. X, a C-corporation, has issued 100 shares and divided them equally (i.e. 25 shares each) between four shareholders, G, X, A and B. The issue is determination of ownership of X shares under the §318 trust attribution rules.

Let’s begin with G. He actually owns 25 shares and is deemed to own all shares owned by the grantor trust T. In other words, G owns a total of 50 shares.

T actually owns 25 shares and constructively owns all of G’s 25 shares. Its further ownership of X’s shares will depend on whether the general §318 downstream trust attribution rules supplement the §318 grantor trust rules. If they do, then T would be deemed a constructive owner of another 50 shares of X stock held by A and B – i.e. T will be deemed to a 100% owner of X. If, however, the special §318 grantor trust rules replace the other grantor trust attribution rules, then T’s ownership will stay at 50 shares total.

Similarly, if the grantor trust rules supplement other trust attribution rules, then A and B each will be deemed to own 50% of X through their 50% beneficiary interest in T. If the grantor trust rules overrule all other §318 trust attribution rules, then there will be no attribution of T’s stock to the beneficiaries and vice-versa.

A final note on this example. A and B would not be deemed to own any of G’s shares due to §318(a)(5)(C) prohibition on re-attribution of G’s stocks to the beneficiaries because these stocks were already attributed to the trust.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

The complexity and importance of US international tax law (in which §318 construction ownership rules play an important role) makes it extremely risky for US taxpayers to operate without assistance from an experienced international tax lawyer.

Sherayzen Law Office is a highly experienced international tax law firm which specializes in US international tax compliance and offshore voluntary disclosures. We have helped hundreds of US taxpayers to successfully resolve their US international tax compliance issues, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

§318 Upstream Trust Attribution | US Foreign Trust Tax Lawyer & Attorney

/in , /by

In a previous article, I discussed the Internal Revenue Code (“IRC”) §318 downstream trust attribution rules. Today, I would like to focus on the §318 upstream trust attribution rules.

§318 Upstream Trust Attribution: Downstream vs. Upstream

There are two types of §318 trust attribution: downstream and upstream. In a previous article, I already covered the downstream attribution rules which attribute the ownership of corporate stocks owned by a trust to its beneficiaries. The upstream attribution rules are exactly the opposite: they attribute the ownership of corporate stocks owned by beneficiaries to the trust. This article focuses just on the upstream attribution.

§318 Upstream Trust Attribution: Main Rule

Under §318(a)(3)(B)(i), all corporate shares owned directly or indirectly by a beneficiary of a trust are considered owned by the trust, unless the beneficiary’s interest is a remote contingent interest. Notice that the proportionality rule does not apply to upstream trust attribution under §318.

For example: if trust T owns 25 shares of X, a C-corporation, and A owns another 25 shares of X, as long as A has a beneficiary interest in T which is not a remote contingent interest, then T will constructively own all of A’s shares of X – i.e. T will own 50 shares of X.

§318 Upstream Trust Attribution: Contingent Interest

If a beneficiary’s interest in a trust is both, remote and contingent, then there is no attribution of stock ownership from the beneficiary to the trust. Hence, the key issue with respect to upstream trust attribution is classification of a beneficiary’s interest in the trust – is it a remote contingent interest or not? Let’s first define what a contingent interest is and then discuss when such an interest is considered remote.

A contingent interest is defined as interest that is not vested. This means that the beneficiary has no present right to trust property and has no present interest in a property with respect to future enjoyment of the trust property. In other words, this interest can only be activated by an occurrence of an intervening event.

§318 Upstream Trust Attribution: Remote Contingent Interest

A contingent interest is remote if “under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property.” §318(a)(3)(B)(i).

Let’s use an example to demonstrate how this rule works. The fact scenario is as follows: trust T owns 40 shares in X, a C-corporation; A, an individual beneficiary, has a contingent (not vested) remainder in the trust which has a value computed actuarially equal to 3% of the value of the trust property; A also owns the remaining 60 shares of X (X issued a total of 100 shares).

In this situation, A’s beneficiary’s interest is contingent because it is not vested and it is remote because its value is less than 5% of the value of the trust property. Hence, no shares of X are attributed from A to T, because A has a remote contingent interest.

It should be noted that T’s shares in X are still attributed to A under the §318 downstream attribution rules; hence, A would constructively own 1.2 shares of X.

§318 Upstream Trust Attribution: Special Situations

I wish to conclude this article with a discussion of two special situations.

First, if beneficiaries are entitled to trust corpus, this is a vested interest. This is case even if the life tenant in the trust’s property has the right to exercise power of appointment in favor of others. Of course, if such right is actually exercised in favor of others, then the beneficiary will lose its vested interest in the trust.

Second, if a beneficiary interest is conditioned upon surviving a life interest, it is considered a contingent beneficiary interest. For example, in Rev. Rul. 76-213, the IRS stated that a beneficiary had a contingent interest, because his remainder interest in the trust would terminate if the beneficiary predeceased the life tenant.

§318 Upstream Trust Attribution: Grantor Trusts and Employee Trusts

While it is beyond the scope of this article to describe them in detail, there are special rules that apply to the attribution of stock from grantor trusts and employee trusts. I will discuss these rules in more detail in future articles.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

The complexity and importance of US international tax law (in which §318 constructive ownership rules play an important role) makes it extremely risky for US taxpayers to operate without assistance from an experienced international tax lawyer.

Sherayzen Law Office is a highly experienced international tax law firm which specializes in US international tax compliance and offshore voluntary disclosures. We have helped hundreds of US taxpayers to successfully resolve their US international tax compliance issues, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

New PFIC Foreign Trust Rules by June of 2018 | PFIC Lawyer & Attorney

/0 Comments/in , /by

On November 9, 2017, the IRS gave a clear signal that it is working on new PFIC Foreign Trust rules and hopes to have these new regulations published by June of 2018. The IRS also indicated that other areas of PFIC rules will be affected and it expects the Subpart F regulations to come out before the new PFIC regulations.

The area of intersection of PFIC rules and Foreign Trust rules is an area of law that has remained murky since the late 1980s. Let’s explore in more detail what exactly the problem is and why the new PFIC Foreign Trust regulations are so important.

PFIC Foreign Trust Rules & Regulations

PFIC Foreign Trust Rules

PFIC Foreign Trust Rules: What is a PFIC?

In general, a foreign corporation that is not a “controlled foreign corporation” (CFC) as defined in IRC section 957, nor a “foreign personal holding company” (FPHC) as defined in IRC section 552, will be determined to be a Passive Foreign Investment Company or (PFIC) if it has at least one US shareholder and meets either one of the two tests found in IRC section 1297: (a) income test: at least 75% or more of the corporation’s gross income is passive income; or (b) asset test: at least 50% of the average percentage of its assets are investments that produce or are held for the production of passive income.

PFIC is a unique US classification that has no equivalents anywhere in the world. The PFIC designation was created by Congress in 1986 (as part of the Tax Reform Act of 1986). In essence, this is an anti-deferral regime meant to deter US taxpayers from deferring or avoiding payment of US taxes by transferring money or investing in passive offshore entities. This is why the PFIC rules are so severe, imposing the highest marginal tax on the income considered as “excess distribution” and converting the rest of the income from capital gains into ordinary income.

PFIC Foreign Trust Rules: Foreign Trust Rules on Distribution of Accumulated Income

The IRS also has a special set of rules concerning foreign trust’s distribution of accumulated income from prior years. In order to analyze these rules, we need to understand two concepts: distributable net income (“DNI”) and undistributed net income (“UNI”). With respect to foreign trusts, in general (and there are exceptions), DNI includes all of the ordinary income and capital gains earned by a foreign trust in current taxable year. If a foreign trust does not distribute its entire DNI in the taxable year when DNI is earned, then, the undistributed portion of DNI (after taxes) becomes UNI.

Hence, whenever we discuss a distribution of a foreign trust’s accumulated income, this means a distribution of UNI in excess of DNI (on FIFO basis). So, what happens if a foreign trust distributes UNI to a US beneficiary?

In general, such distributions of UNI are taxed according to the infamous “throwback rule”. The throwback rule is complex and I can only state here a very simplified description of it. In general, under the throwback rule, distributed UNI will be taxed at the beneficiary’s highest marginal tax rate for the year in which UNI was earned. In other words, the throwback rule divides up UNI back into DNI portions for each relevant taxable year (but not exactly; this is an assumed DNI, not an actual one), adds these portions to the already-reported income on the beneficiary’s US tax returns and, then, imposes the tax on this income.

The throwback rule, however, does more than just add the income to the tax returns – it adds the income always as ordinary income, even if the original undistributed DNI consisted of long-term capital gains. Moreover, the throwback rule imposes an interest charge on the additional “throwback” taxes; the interest accumulates in a way somewhat similar to PFIC rules.

There is a way to mitigate the highly unfavorable consequences of the throwback rule called the “default method” (the name does not make much sense because you can use it only in specific circumstances). In general, you can use the default method in situations where the foreign trust does not provide its US beneficiaries with the information sufficient to identify the character of the distributed income. It is beyond the scope of this article to describe this method in detail, but, there are potentially highly unfavorable consequences to using the default method as well.

PFIC Foreign Trust Rules: the Inconsistency Between PFIC Rules and Foreign Trust Rules With Respect to Accumulated Income

Now that we have a general familiarity with PFIC rules and the foreign trust UNI distribution rules, we can now understand the area of confusion between PFIC rules and Foreign Trust rules that the IRS wishes to finally clear up by June of 2018. The confusion arises when both anti-deferral regimes are combined into PFIC Foreign Trust rules.

Let’s clarify this issue further. The basic problem occurs whenever a foreign trust distributes UNI that originates from accumulated PFIC income. For example, in a situation where a foreign trust received PFIC dividends and did not distribute them as part of its DNI distribution, such dividends would be added to the trust’s UNI. In this situation, if the trust distributes its PFIC UNI and we just follow the standard UNI rules, the PFIC rules would never be taken into account. The IRS, however, never said that the throwback rule or the default method should trump PFIC rules; it is also unclear about what should be reported on Form 8621 (for indirect ownership of PFICs).

On the other hand, if a taxpayer calculates his tax liability under the PFIC rules, then, he cannot comply with his Form 3520 requirements. The IRS also never stated that PFIC rules should triumph over either the throwback rule or the default method for UNI distributions. In other words, there is no clear guidance on what to do in this situation.

There is simply no compatibility between the foreign trust’s UNI distribution rules and the PFIC rules: one of them has to triumph or a completely new set of regulations has to be issued by the IRS to address the PFIC Foreign Trust rules. As an international tax attorney, I hope that the IRS keeps its word and resolves this highly important dilemma of the US international tax law.

Contact Sherayzen Law Office for Help With PFIC Foreign Trust Rules and Other International Tax Issues

If you are struggling with the PFIC Foreign Trust rules or you have any other issues concerning your compliance with your US international tax obligations, contact Sherayzen Law Office for professional help.

Sherayzen Law Office has helped hundreds of US taxpayers around the globe with their US tax compliance issues, including those concerning the PFIC rules and foreign trust rules. We can help You!

Contact Us Today to Schedule Your Confidential Consultation!