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Trusts, foundations and charities
Are trusts legally recognised in your jurisdiction? If so, what types are available and most commonly used?
Yes, trusts are recognised under US law. Trusts in the United States are generally governed by state (not federal) law. Trust laws vary from state to state.
What rules and procedures govern the establishment and maintenance of trusts?
While rules and procedures vary from state to state, more than half of the states have enacted (with variations) the Uniform Trust Code, which is intended to create uniformity in trust laws among the states.
How are trusts taxed in your jurisdiction?
For federal tax purposes, a trust is classified as a domestic (US) trust or a foreign trust.
A trust is ‘foreign’ if it fails to satisfy either the ‘court test’ or the ‘control test’. A trust will fail the court test if no US court can exercise primary supervision over the trust’s administration. A trust will fail the control test if US persons do not have the authority to control all substantial decisions of the trust. If a trust satisfies both tests, it is a domestic trust.
Federal income tax rules distinguish between ‘grantor’ and ‘non-grantor’ trusts. A grantor trust is not treated as a separate taxable entity. Instead, the settlor (or grantor) of the trust is treated as the direct owner of all of the trust’s assets for federal income tax purposes. Distributions from a grantor trust to beneficiaries other than the grantor are generally treated as gifts by the grantor to the beneficiaries, who are not taxed on the amount received (but in the case of a distribution received from a foreign trust, only if they comply with certain US tax reporting requirements).
Generally, a non-grantor trust is treated as a separate taxable entity and is subject to the same ordinary income tax rates as individuals (10% to 37%, although trusts will reach the maximum tax rate at only $12,500 of taxable income). The US tax rules for non-grantor trusts (US or foreign) are designed to:
- allocate the taxable income of the trust between the trust and its beneficiaries; and
- ensure that such income is taxed only once.
These objectives are achieved through the concept of ‘distributable net income’ (DNI). For US trusts, DNI is similar to the trust’s fiduciary accounting income and includes (among other things) interest and dividends, but usually not gains allocable to corpus. However, DNI for foreign trusts includes such gains.
US beneficiaries receiving a distribution from a non-grantor trust will generally include the amount of the trust’s DNI that is distributed (or required to be distributed) to them in their taxable income. Additionally, the character of the DNI received by the trust (eg, interest or dividends or tax-exempt income) passes through to the beneficiary. DNI attributable to interest and dividends is taxable to an individual US beneficiary at ordinary income at rates up to 37%, whereas long-term capital gains are generally taxable at a flat 20% rate (with the additional 3.8% Medicare tax on net investment income). If and to the extent that a non-grantor trust does not (and is not required to) distribute DNI, such DNI is taxable to the trust.
Foundations and charities
Are foundations and charities legally recognised in your jurisdiction? If so, what forms can they take?
In the United States, ‘foundation’ generally refers to a trust or corporation that is organised under state law and operated exclusively for charitable purposes. These foundations typically apply for exemption from federal and – if appropriate – state income taxes.
Private non-charitable foundations are not generally created in the United States. However, private non-charitable foundations properly formed in other jurisdictions will be recognised in the United States.
What rules and procedures govern the establishment and maintenance of foundations and charities?
In addition to state laws regulating the formation and operation of charitable organisations, tax-exempt charitable organisations are subject to strict federal tax laws to ensure that the organisation’s funds are used for religious, charitable, scientific or educational purposes and not for the private benefit of individuals or organisations. Most exempt organisations are classified as public charities or private foundations. Public charities and private foundations may not intervene or campaign for or against a candidate for public office. In addition, private foundations are subject to special federal excise taxes (eg, a tax against self-dealing) which are designed to inhibit foundations from engaging in abusive transactions.
Other than qualifying charities established for religious purposes, most charities are subject to annual federal tax reporting requirements and, in many cases, state reporting requirements.
How are foundations and charities taxed?
In the United States, ‘foundation’ generally refers to a trust or corporation that is organised under state law and operated exclusively for charitable purposes.
Charitable organisations in the United States may apply for exemption from federal income tax and, in many cases, state income tax. However, charitable organisations are subject to federal income tax on income from certain business activities that are unrelated to their charitable purposes.
Contributions to exempt charitable organisations may – subject to certain limitations – qualify for a federal income tax deduction to the donor.
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