To begin with, an arrangement is a trust if its purpose is to invest its
trustees with responsibility for the protection and conservation of property
for beneficiaries who cannot share in the discharge of this obligation.
A trust is the presence of a business purpose and associates that courts
have typically found to distinguish an association taxable as a corporation
from a trust.
According to the 1996 Small Business Act, a trust is considered domestic
if U.S. courts can exercise primary supervision over its administration
and U.S. persons are in control of all substantial trust decisions.
If a foreign or domestic trust has a grantor who is not a U.S. citizen,
more limited rules apply in determining whether the trust will be considered
a grantor trust. A non-grantor trust, on the other hand, is a separate
taxpayer for U.S. federal income tax purposes. For purposes of calculating
taxable income, a trust receives a deduction for distributions to its
beneficiaries to the extent these distributions carry out the trusts distributable
net income, or DNI, for the taxable year.
The “throwback rule” is one of the most important parts of
the tax code dealing with taxing provisions which apply to foreign trusts.
This regulation applies to distributions of accumulated income from foreign trusts.
Foreign trusts which do not distribute all its DNI in the current year
will see their after-tax portion of the undistributed DNI become “undistributed
net income,” or UNI. Any distributions for subsequent tax years
in excess of the DNI of the current taxable year will be considered to
come next from UNI.
Another major provision applying to transfers of foreign trusts is in section
684 which provides that any transfer of property by a U.S. citizen to
a foreign trust is considered a taxable exchange of the properly.
Cash loans, except as provided in regulations, are now treated as a trust
distribution which is generally taxable under the normal trust rules.
However, if the loan within the ambit of section 643(i) of the tax code
is made to a person other than a grantor or beneficiary it will be treated
as a distribution to the grantor or beneficiary to whom the person is related.
Rules regarding how foreign trusts are taxed are complicated and there
are many issues which are not specifically addressed by the statutory
provisions and for which there is no further public guidance and little