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

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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!

Exceptions to Foreign Trusts: Business Trusts

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As I mentioned in an earlier article, U.S. tax law includes a number of important exceptions to legal definition of a foreign trust – i.e. an entity can be classified as a foreign trust for legal purposes and not as a trust (but as a corporation or a partnership) for U.S. tax purposes. This is also true with respect to domestic trusts, but, in international context, the issues are far more complicated and require detailed exploration of facts and, often, local laws. In this article, I would like to discuss one of the most common exceptions to foreign trusts – business trusts.

Business Trusts Taxed as Corporations or Partnerships

Where an entity is organized as a trust but engages in the active conduct of trade or business, the IRS may re-classify this trust as a “business trust” and tax it as a corporation or partnership. The most relevant primary law on this point can be found in IRS Regs. §301.7701-4(b):

There are other arrangements which are known as trusts because the legal title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for purposes of the Internal Revenue Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit-making business which normally would have been carried on through business organizations that are classified as corporations or partnerships under the Internal Revenue Code. However, the fact that the corpus of the trust is not supplied by the beneficiaries is not sufficient reason in itself for classifying the arrangement as an ordinary trust rather than as an association or partnership. The fact that any organization is technically cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as beneficiaries, will not change the real character of the organization if the organization is more properly classified as a business entity under § 301.7701-2.

Let’s explore these regulations in more depth in order to have a clear idea of the general test for business trusts.

Most Important Features of Business Trusts for Federal Income Tax Purposes

There are two most important factors in determining whether a trust is a business trust. The first and most important distinction between ordinary trusts and business trusts is the conduct of a “profit-making business” which “normally” would have been done by a business entity. It is important to understand that it is not simply the ownership of business assets which re-classifies ordinary trusts in business trusts; rather, while ordinary trusts must be created for the purpose of conservation and preservation of assets for beneficiaries, business trusts should be created for the purpose of the profit-making activities.

How does one determine the purpose for which a trust is created? There are various factors, including the history of the trust. The trust agreement (the document that creates the trust), however, is the key document on which the IRS will focus.

The second important feature of business trusts concerns domestic and foreign trusts which have associates to conduct an active trade or business for their benefit. In such cases, the trusts will be reclassified as business trusts and taxed as corporations or partnerships.

Both of these factors in determining the business nature of a trust rely are highly dependent on facts and require minute analysis of a trust’s history and circumstances. The help of an experienced international tax lawyer is indispensable in this matter.

Contact Sherayzen Law Office for Professional Help With Trust Classification

If you are a beneficiary or grantor of a foreign trust, contact Sherayzen Law Office for professional help in determining the classification of the trust. The founder of our firm, Mr. Eugene Sherayzen, is a highly experienced international tax lawyer who has helped hundreds of taxpayers in and outside of the United States with their U.S. international tax compliance issues.

Contact Us Today to Schedule Your Confidential Consultation!

Foreign Trust Tax Treatment in the United States: Historical Overview

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Over the years, the US tax treatment of foreign trusts has undergone dramatic changes. It is important to study and understand this history in order to properly understand and interpret current US tax laws concerning foreign trust. In this essay, I will provide a broad overview of the history of foreign trust tax treatment in the United States since before 1962 until the present time.

Foreign Trust Tax Treatment Prior to 1962

Before 1962, the US tax laws treated in the same manner all foreign trusts, whether they had a US beneficiary or foreign one. A complex foreign trust established by a US grantor for the benefit of a US beneficiary was taxed similarly to the one established by a foreign granter for a US beneficiary. Moreover, since foreign-source income of a foreign trust was not included in the trust’s gross income for US income tax purposes, this trust would not have any DNI (distributable net income)!

Such treatment of foreign trusts led to a lot of abuse whereby large portions of income were never taxed in the United States. For example, prior to 1962, a foreign trust’s income would not be subject to US taxes in a situation where the trust was located in a country with low or no income taxes and the corpus consisted solely of foreign assets.

While in some situations US beneficiaries might have been taxed when the trust income was actually distributed (under the regular five-year throwback rule), careful tax planning could have prevented even such taxation of the beneficiaries in light of the fact that foreign-source income was excluded from DNI. Moreover, distributions of accumulated foreign trust income contained no undistributed net income (UNI) and were not subject to taxation under even the limited five-year throwback rule.

The Watershed Legislation in Foreign Trust Tax Treatment: the Revenue Act of 1962

The foreign trust tax treatment changed dramatically with the Revenue Act of 1962. The new legislation introduced two major changes to foreign trust tax treatment in the United States. First, it changed the calculation of DNI by requiring foreign trusts to add foreign-source income to it (unless such treatment was exempt by a treaty). Moreover, foreign trusts with US grantors now had to include capital gains in DNI.

Second, the Revenue Act of 1962 created the throwback rule on accumulation distributions from a foreign trust if the trust was created by a US person. Furthermore, important exceptions to throwback rule, such as exclusions for emergency distributions of accumulated income, were made unavailable to foreign trusts by the Act. Finally, the throwback rule became unlimited for foreign trusts while there was a five-year limitation on its application to domestic trusts.

Despite these profound changes in the foreign trust tax treatment, the Revenue Act of 1962 still failed to eliminate some important advantages of using foreign trusts to lower US tax liability. For example, the unlimited throwback rule did not seriously impact the foreign trust advantages in its ability for potentially unlimited tax deferral and tax-free income accumulation. Of course, this meant that the possibility of the rate of earnings of a foreign trust was likely to be much greater than that of US domestic trusts.

Furthermore, nothing was done to limit the ability of the US grantor and beneficiaries (and their families) to access undistributed funds of a foreign trust. For example, they could still receive these funds through loans, private annuities, like-kind exchanges and other similar “indirect” methods.

Finally, with respect to foreign trusts with US grantors, the foreign trusts were required to allocate capital gains to DNI. This meant that every distribution by a foreign trust contained a mixture of ordinary income and capital gains. US domestic trusts could not do that, because capital gains of a domestic trust could not be distributed until current and accumulated ordinary income was distributed.

Thus, perversely, the new foreign trust tax treatment afforded foreign trusts an important advantage in the form of its ability to distribute part of its capital gains to the beneficiaries more quickly than a domestic trust. This advantage became especially evident once the unlimited throwback rule was extended to domestic trusts in 1969.

Tightening of Screws in the Foreign Trust Tax Treatment: the Tax Reform Act of 1976

By 1976, these obvious advantages in the foreign trust tax treatment became unacceptable for the US Congress. Therefore, it acted in a major piece of US tax legislation known as the Tax Reform Act of 1976. While the Act was very broad, there were five key changes to the foreign trust tax treatment in the United States.

First, the new legislation re-classified foreign trusts that were created by US persons and had or could potentially have at least one US beneficiary as a grantor trust under IRC Section 679.

Second, the Act of 1976 required an automatic inclusion of capital gains of a foreign trust in the foreign trust’s DNI.

Third, it eliminated the loophole with respect to foreign trust distributions of income that accumulated prior to a beneficiary’s twenty-first birthday. Now, such distributions were taxed.

Fourth, with the obvious desire to attack the tax advantage in foreign trust tax treatment with respect to accumulated income, the Congress imposed a 6% simple interest charge on the tax imposed on a beneficiary of a foreign trust with respect to accumulations after December 31, 1976.

Finally, the last major change attacked the ability of US grantors to avoid US capital gain taxes by transferring appreciated assets into foreign trusts. The Act of 1976 imposed a 35% excise tax on the transfer of all appreciated assets to a foreign trust by a US grantor, unless the grantor elected to recognize the gain at the time of the transfer.

Changing the Foreign Trust Tax Treatment under IRC Section 672(f)

Another change in the foreign trust tax treatment came under the Revenue Reconciliation Act of 1990 with respect foreign grantor trusts that had a foreign grantor and a US beneficiary who had made gifts to the foreign grantor. This new law was summarized in IRC Section 672(f). Section 672(f) states that, in a situation where a foreign trust has a US beneficiary and should have been a grantor trust under the ordinary grantor trust rules found in IRC Sections 671 through 678 but for the fact that the grantor was a foreign person, this trust should be treated as owned by the trust’s US beneficiary to the extent that this beneficiary has made prior gifts to the foreign grantor.

There is still a small exception that a “gift shall not be taken into account to the extent such gift would be excluded from taxable gifts under section 2503(b).” 26 U.S.C. Section 672(f)(5)

1996 and 1997 Changes in the Foreign Trust Tax Treatment

The last major change in foreign trust tax treatment that I wish to mention here was introduced in the Small Business Job Protection Act of 1996 (as slightly modified by the Taxpayer Relief Act of 1997). The Act of 1996 introduced major revisions in the rules of foreign trust tax treatment, arguably on the scale of the Tax Reform Act of 1976.

Five major areas of foreign trust tax treatment were in focus. First, the definition of a foreign trust was clarified with a strong bias toward treating a trust as a foreign trust. Two new tests, the court test and the control test, were introduced (and clarified further in the Treasury regulations). These changes were codified in IRC Section 7701.

Second, the reporting requirements for foreign trusts (Forms 3520 and 3520-A) were introduced. This was a major change in the reporting burden for US taxpayers and foreign trusts with US beneficiaries.

Third, the penalties for failure to report transfers to a foreign trust were introduced.

Fourth, new rules were put in place to reduce the utility of foreign trusts by individuals who were planning to become US residents.

Finally, new restrictions were placed to reduce the utility of using foreign trusts by individuals who were planning to surrender their US residency or citizenship.

Contact Sherayzen Law Office for Tax Help With Foreign Trusts

Over the years, one can see profound changes in the foreign trust tax treatment; in this brief article, I only focused on some of the major changes in the foreign trust tax treatment, but there were other developments that took place (for example, FATCA compliance for foreign trusts).

These changes in foreign trust tax treatment generally indicate the trend toward stricter regulation of foreign trusts, increasing reporting burden on US taxpayers and foreign trusts, and the reduction in any type of an income tax advantage of foreign trusts. In fact, the foreign trust law has become so complex that one should not try to resolve these matters without the help of an experienced tax professional.

Despite these burdens, there is still a large number of foreign trusts with US grantors and US beneficiaries. The latter situation (i.e. US beneficiaries) often occurs when a foreign beneficiary becomes a US beneficiary through immigration. Oftentimes, these new US beneficiaries are not even aware of the existence of foreign trusts until significant US tax non-compliance occurs.

This is why it is so important to contact Sherayzen Law Office for professional help with respect to your foreign trusts as soon as possible. We have helped US beneficiaries, US grantors and foreign trusts around the world to do proper tax planning and comply with US reporting requirements (including Forms 3520, 3520-A and the voluntary disclosures associated with these forms). We can help You!

Contact Us Today to Schedule Your Confidential Consultation!