Since both trusts and foreign corporations can be intermediaries, providing a barrier to estate tax, the question arises of which should be preferred.
Historically, many practitioners have opted for the flexibility and lower tax rates of a trust structure over a corporation. Following the US tax reform in December 2017, however, foreign corporations are often the favoured vehicle today. This may, however, change should corporation tax rates increase to 28% as proposed by the President.
Whichever option is used, careful planning is required.
In respect to trusts, the key is to ensure the settlor does not retain powers or benefits such that the property would be considered part of the estate at death. An additional consideration is whether the trust is funded with cash and acquires property in its own name or if the property itself is contributed to trust.
Where a corporation is used, it is important to show the company is properly managed so that it is not disregarded by the IRS as a fake company.
Where the property is held in a corporate vehicle, the base cost of the shares inherited may be the market value at the date of death. There is no corresponding uplift in the base cost of the property itself within the company. Similarly, an automatic uplift in base cost does not apply where a trust is an intermediary for the purpose of estate tax. In both cases, this can be problematic for heirs who wish to dispose of the property rather than keep it within the corporation or trust. Tax will be due on any gain realised.
Furthermore, both trusts and foreign corporations raise extra reporting requirements for heirs who happen to be US citizens or residents.
It should also be noted that a disposal for capital gains tax purposes can occur if the property is initially owned personally and later contributed to a foreign corporation. Equally, gift tax can arise on the contribution of the property to a trust, whether onshore or offshore.
Finally, the tax rules applying in the taxpayer’s country of tax residency always need to be considered. Regardless of the US tax code, in some jurisdictions, foreign corporations and trusts may be inefficient vehicles when it comes to tax. This should always be part of the considerations when deciding whether to use trust, a company or neither.