Issue: What are the legal and tax consequences of an
outright gift of stock by a foreign person (defined below) to a
foreign individual compared to a gift of stock to a foreign trust
for the benefit of that individual?
Note: Recent changes in U.S. tax laws could subject the foreign trust to U.S. taxation if the foreign grantor becomes a resident or citizen of the U.S. within 5 years of the trust's creation. If the trust will have U.S. beneficiaries, then the trust must be revocable by the foreign grantor; otherwise, the U.S. beneficiaries will be taxed on their pro-rata share of the trust's income at the time of distribution. Also, amounts accumulated by the trust for later distribution to U.S. beneficiaries are subject to a new (and higher) interest charge on the deferred taxes.
Note: The term, "foreign individual" or "foreign person" means a non-U.S. citizen or resident. A "grantor" is the person creating a trust. A "donor" is the person making a gift. A "donee" is the person receiving a gift. Under U.S. tax law, in general, donors are taxed on gifts; donees receive gifts tax-free. A foreign person who is a donor is usually not taxed on gifts of foreign property (real property, cash, tangible and intangible property, located outside the U.S.). Whether property is subject to U.S. gift tax is a complex subject and is covered at Estate and Gift Transactions for Foreign Taxpayer.
Answer: An outright gift of stock to an individual is
a transfer of ownership to that individual. The individual has
the unrestricted right to sell or assign that stock to any other
person. The individual is taxed on the dividend income from the
stock, any gains from the sale of the stock, and will have an
estate tax based on the value of the stock.
In contrast, a foreign trust can be structured so that a
foreign beneficiary can avoid all income and estate taxes on the
stock. The trust can protect against the beneficiary selling or
assigning the stock, or voting his interest in a manner
detrimental to the corporation. The trust can protect a
beneficiary's interest against a spouse, creditor or an
expropriating government.
| Transfer of Ownership? | Gift recipient owns the stock outright. A trust owns the stock and the beneficiary is only entitled to the income generated from the stock. | |||
| Right to sell or assign stock? | Gift recipient may give or sell the stock to another person. A transfer can occur involuntarily, such as a seizure of assets by the taxing authorities or other creditor, or an expropriation by a hostile government. | |||
| Right of creditor to take the stock in a lawsuit? | A beneficiary's interest in a trust cannot be seized by a creditor. Also, the assets of a trust cannot be used to satisfy a creditor's claim against a beneficiary. | |||
| Possibility of stock going to a spouse in a divorce? | There is a possibility that if the stock becomes community or marital property, a judge can award it to the other spouse in a divorce. This cannot happen with a trust. | |||
| Continuity of management of corporation? | Gift recipient owns the stock outright and can vote in any manner he chooses. With a trust, the trustees or a management committee are the decision makers. This is important if the grantor wants the corporation to continue with its on-going projects. | |||
| Income Tax? | The owner is taxed on income (usually dividends), the trust beneficiary is not taxed. | |||
| Capital gains tax on sale of stock? | Gains from the sale of stock are taxed to the owner; a beneficiary does not pay tax on the sale of stock by a trust. | |||
| Estate Tax? | The stock is part of the owner's estate (as are the proceeds from the sale of stock), the stock is not part of the trust beneficiary's estate. | |||
| Court supervised probate? | Stock held in an individual's name is subject to probate, stock held by a trust is not. | |||
| Gift tax on a later transfer to donee's children? | A later stock transfer by the owner to his children is subject to gift tax. A trust which provides for the beneficiary's children as additional beneficiaries is exempt from a gift tax. | |||
| Income interest retained by donor of stock? | Once stock is given away, the donor (giver) has no rights to the income. With a trust, the donor can retain an income interest which can be used to support the donor, if necessary. | |||
| Right of revocation of the transfer? | The donor of a trust may retain the right to revoke the trust, if necessary, hence, the transfer is not complete until the donor dies. | |||
| Secrecy and privacy? | An owner of stock must declare it as an asset and pay taxes on the income from the stock. A trust formed in a tax-haven, such as BVI or Cayman, is subject to secrecy and privacy laws; consequently, the terms of the trust are usually shielded from the grantor's and beneficiary's government. | |||
| Successive estate taxes on the same stock? | With the outright ownership of stock, each time the owner dies, there will be an estate tax and possibly a probate on the stock. With a trust, there will never be a probate and an estate tax will occur only when the stock is distributed to the beneficiary, which could occur, in some jurisdictions 150 years after the trust's formation. | |||
| Possibility of expropriation of corporation or its assets? | When a corporation is owned outright, there is the possibility that its assets may be expropriated by a hostile government. If assets are owned in a trust located in a jurisdiction with secrecy laws, the corporation's assets are generally protected against expropriation. | |||
| Tax-free use of property? | Beneficiaries can use trust property, such as a vacation home or other assets owned by the trust, tax-free. Loans from a trust to a beneficiary can be structured on a tax-free basis. | |||
Conclusion: A trust offers a multitude of advantages
over individual ownership of stock. Trusts should be used
whenever possible to protect assets.