Many international Non-Resident Alien (NRA) grantors are establishing South Dakota Foreign Grantor Trusts (FGTs) for foreign beneficiaries and foreign property as well as U.S. beneficiaries and property.
Foreign Grantor Trust
South Dakota is frequently the jurisdiction of choice for NRAs due to the state’s trust protector, directed trust, privacy, tax, asset protection, forced heirship and other modern trust statutes. A South Dakota Foreign Grantor Trust is established as a “foreign” trust for United States tax purposes and therefore is treated the same as an offshore trust, but administered by a U.S. trustee.
Typically, this is a popular trust for NRAs with foreign beneficiaries and property who are seeking political stability, protection of property, and non-blacklisted countries.
The NRA will be treated as owner of the trust under U.S. law if the trust is revocable or if the trust provides for the NRA and their spouse for their lifetimes. Any distributions from the FGT to U.S. beneficiaries will be deemed gifts and not income to the beneficiary. The FGTs can have U.S. as well as foreign beneficiaries. In cases where the trust is drafted as irrevocable, but the grantor has U.S. beneficiaries he or she wishes to distribute gifts to, the trust may make a distribution to the grantor or grantor’s spouse, and then from the grantor or grantor’s spouse to the U.S. beneficiaries. Upon their death, the trusts are distributed outright or in trust to their children, who can be either U.S. citizens or foreign citizens.
At the death of Grantor, the Foreign Grantor Trust will convert to a Foreign Non-Grantor Trust (“FNGT”). The trust can remain a FNGT and make distributions to the remaining foreign beneficiaries (i.e. spouse, children). Alternatives would be to transfer outright or in trust to children and/or provide the beneficiaries a limited power of appointment so as to provide them flexibility to transfer assets to other vehicles that may be more beneficial for their specific circumstances (e.g., home country law). If the trust coverts to a FNGT and has U.S. beneficiaries, distribution options to avoid the negative tax consequences of the FNGT for the U.S. beneficiaries (for further discussion see below) include: 1.) making distributions of income and realized capital gains annually to avoid accumulated earning issues 2.) distribution to a U.S. Resident Trust 3.) re-domesticate the FNGT to a domestic trust 4.) terminate the FNGT and pour over at death of grantor to a U.S. Dynasty Trust or 5.) provide the beneficiaries a limited power of appointment to distribute.