Trusts and Taxes – Double Trouble?

Since January 1, 2003, Israel has changed its method for collecting tax from its residents by using a system called "personal taxation". This means that all Israeli residents have to report all their income and pay tax from any asset or account regardless of its geographical source.

However, since 2008, in honor of Israel’s 60th Independence Day, the Israel Tax Authority (ITA) introduced a special tax regime whereas “new immigrants” and “senior returning residents” (Israelis who have lived outside of Israel for at least 10 years) are entitled to a 10 year tax exemption on their non-Israeli sourced income and capital gains. This tax exemption applies not only to investment income but also to salary, business income, and pensions from non-Israeli sources. There is also a 10 year exemption from filing Israeli tax returns if the only income is from foreign assets. Once the 10 year tax holiday ends, the Israeli resident will be liable to report and pay tax on his foreign income like any other longstanding Israeli resident.

This special tax exemption, that provides substantial tax benefits was created in order to encourage people to make “Aliya”, i.e. to relocate/return to Israel.

Trusts

Many Israeli residents who have a US citizenship are also beneficiaries of a US trust.   In general, trusts that are classified in Israel as “resident trusts”, (meaning, a trust that includes at least one settler or a beneficiary who is an Israeli resident), are subject to tax on their worldwide income.

Nevertheless, in the event that the Israeli beneficiary is a new immigrant or a senior returning resident who is entitled to the 10 year exemption, this benefit extends also to any trust in which he is a settlor or a beneficiary (assuming there are no other Israeli resident settlors or beneficiaries, since Israeli law extends the 10-year new immigrant benefits only to trusts that have no Israeli resident beneficiaries, other than new immigrants).

At the end of the 10 year exemption, taxes will apply to the trust income on a worldwide basis.

Since the new regime was implemented in 2008, new immigrants are now starting to be confronted with the fact that as of 2019, the family trust is not only subject to taxes and tax return filings but also the tax is imposed on worldwide income, even with respect to the portion that is attributed to a non Israeli beneficiary!

Another tax consequence that could be relevant is with regard to a Relative Trust (RT).

A RT is a trust for which there is an adequate first-degree family connection between the non-Israeli settlor and all of the Israeli-resident beneficiaries (e.g., parents or children, grandparents or grandchildren during the lifetime of the settler and/or his spouse.

As long as the settler (or spouse) is still alive and as long as the beneficiaries are related to the settler, the tax that applies is only regarding the actual portion/income attributed to the Israeli beneficiary (and if he is entitled to an exemption, no tax will apply). However, once the trust is no longer defined as a RT, the trust in its entirety is subject to Israeli taxation even if only one beneficiary resides in Israel.

Conclusion
Trust are usually created in order to give the settlor a peace of mind knowing that his family will be provided for and his wishes will be followed upon his death in a tax efficient matter. However the trust might have been prepared quite a long time ago, and not all circumstances could have been foreseen.  

The relocation of the beneficiaries to a different country, and /or changes in the family structure might require for the original trust to be reviewed in order to make sure it continues to maintain its advantages.

In this article, we have discussed just a few of the issues that might arise as a beneficiary of a foreign trust and we strongly recommend to seek professional advice in order to mitigate or maybe even prevent any adverse tax consequences that might arise, taking into consideration that some changes to the trust structure might be required. 

 

The content of this article is intended to provide a general guide to the subject matter and is not a substitute for legal consultation. Specific legal advice should be sought in accordance with the particular circumstances.

 

Dave Wolf, a U.S. and Israeli tax attorney, is a partner at Dave Wolf & Co. Law Firm, a law firm specializing in taxation and wealth management and can be reached at 02-626-2595

Mirit Hoffman (Reif), a qualified Israeli attorney and a registered trust and estate practitioner (TEP), is the owner of Mirit Hoffman Law Office that deals mainly with individual US & Israeli taxation, Israeli voluntary disclosure, estate planning and Enduring Power of Attorney forms. She can be reached at mirit@lawmirit.com.