23 July 2019

A Quiet Year—But Change is on the Horizon

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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.  

Click here to access the full article on WealthManagement.com

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