For professional trustees, 2014 provided a hiatus from the
seemingly never-ending changes in laws, rules and regulations that have been
imposed on trusts for more than a decade. Since the enactment of the Bush
tax cuts, trustees have faced annual changes in federal tax laws and financial
regulations. These changes created an uncertain environment in which to plan
and operate. Finally, this past year, trustees enjoyed a break from this
shifting federal landscape. Nevertheless, 2014 prepared trustees for two
significant regulatory changes: implementation of the Foreign Account Tax
Compliance Act (FATCA) and “unbundling.”
FATCA targets non-compliance by U.S. taxpayers who have
non-U.S. assets—an attempt by the Internal Revenue Service to ensure that U.S.
persons pay taxes on their worldwide assets. It should be simple, but, of
course, it’s anything but. Not only does FATCA require U.S. taxpayers to report
their offshore assets, but also, it requires foreign financial institutions
(FFIs) to report accounts owned by U.S. taxpayers. The broad definition of
“FFI” creates a challenge for trustees because it includes non-U.S. trusts.
Therefore, a trustee of a non-U.S. trust is subject to FATCA reporting and
registration, even if the U.S. trustee is a U.S. financial institution. This
requirement is applicable regardless of whether the trust is subject to U.S.
law and whether all of the trustees are U.S. trustees. A trust is non-U.S. for
income tax purposes if a non-U.S. person controls any substantial trust
decision. Similarly, a non-U.S. private investment company is an FFI subject to
FATCA registration and reporting.
The consequences of failing to register and report are
severe. A 30 percent U.S. withholding tax will be imposed on certain
U.S.-source payments made to the FFI. These payments include not only dividends
but also interest and proceeds of sale. Interest and proceeds would, typically,
not otherwise be subject to U.S. withholding under Chapter 3 of the Internal
Revenue Code. U.S. financial institutions must adapt their accounting systems
to take into account the potential need to collect this withholding.
The other regulatory requirement that trustees will confront
in 2015 is the “unbundling” of fiduciary fees contemplated in final regulations
under IRC Section 67(e), for taxable years beginning on or after Jan. 1, 2015. Many
professional fiduciaries charge one fee that includes both trust administration
and investment management. The term “unbundling” refers to the need for a
trustee to separate out from that single fee the amount that represents
investment management fees that are subject to the 2 percent floor for
deductibility of miscellaneous itemized deductions; the balance of the fee
represents the amount that can fully be deducted on the trust’s income tax
return as purely trust administration.
Some commentators believe that in those instances in which
the trust only charges one fee, unbundling is unnecessary because the trustee
is the legal owner of the trust corpus; therefore, it renders no “advice” to
itself. This situation is distinguishable from a set of facts in which an
individual hires an outside investment advisor and takes instructions from
that advisor, which are the facts in the Knight case that interpreted
the IRS regulations. When a trustee invests assets in a trust of which the
trustee acts solely as trustee, it acts for itself as principal and doesn’t
render advice to itself. This concept is reinforced in the Investment Advisers
Act of 1940, which specifically exempts state and federally chartered trust
companies from the definition of “investment adviser.”
These commentators make an additional argument against
unbundling—that if a value is assigned to all of the non-investment activities
performed by professional trustees, in fact, the professional trustee may be
charging nothing for investment advice whatsoever. These services include
reviewing trust documents, determining proper situs and governing law,
allocating receipts to income and principal, considering tax elections,
maintaining proper accounts, providing valuations, determining distributions
and reviewing a transfer tax decision, to name a few.
With such strong arguments in favor of no requirement to
unbundle, this regulatory change may not be as burdensome as initially
believed. Professional trustees must still be careful to assure that fees they
receive from outside investment advisors are treated as miscellaneous itemized
deductions. For those professionals, however, who don’t seek investment advice
and execute investment decisions for themselves, the burden of unbundling
wouldn’t seem to apply.
Although 2014 has been a relatively quiet year of change for
professional trustees, the seeds have been planted to create many changes in
2015 and beyond.
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