When a Grantor Trust is a Nongrantor Trust

Hello and welcome to The Friday Edition. I’m Phil Hodgen, your faithful correspondent. This week is a quickie.

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When a Grantor Trust is a Nongrantor Trust

Here is a quick discussion of an important topic for those of you who handle expatriations. What you think is a grantor trust might, for exit tax purposes, be classified as a nongrantor trust.

IRC 877A(f) is the provision that talks about distributions from nongrantor trusts to covered expatriates. These distributions may trigger recognition of gain, and the trustee may have a withholding requirement. IRC §877A(f)(1).

IRC §877A(f)(3) defines nongrantor trust like this:

For purposes of this subsection, the term “nongrantor trust” means the portion of any trust that the individual is not considered the owner of under subpart E of part I of subchapter J. The determination under the preceding sentence shall be made immediately before the expatriation date.

Notice 2009-85, Section 7.A rephrases this in an easy-to-understand way, eliminating some of the embedded ambiguities:

For this purpose, section 877A(f)(3) provides that the term ”nongrantor trust” means the portion of any trust, whether domestic or foreign, of which the covered expatriate is not considered the owner under subpart E of Part I of subchapter J, determined as of the day before the expatriation date.

The expatriation date, of course, is the expatriation date of the covered expatriate. IRC §877A(g)(3). ## Three Kinds of Trusts

The Internal Revenue Code classifies trusts like this:

A trust has an owner, as defined in the grantor trust rules (IRC §§671 – 679). We call these “grantor trusts.”
A trust does not have an owner, as defined in the grantor trust rules (IRC §§671 – 679). We call these “nongrantor trusts.”

IRC §877A(f)(3) says:

If a trust has an owner, and the owner is NOT the covered expatriate who is receiving a distribution from the trust, then the portion of the trust that is not owned by the covered expatriate is a “nongrantor trust.”

If you put those two ideas together, you have three types of trusts:

A grantor trust that has the covered expatriate as an owner. For IRC 877A(f), this is a grantor trust.
A grantor trust that has someone other than the covered expatriate as the owner. For IRC 877A(f), this is a nongrantor trust.
A nongrantor trust. For IRC 877A(f), this is a nongrantor trust. ## Grantor Trust IRL, Nongrantor Trust for IRC 877A(f) A simple example of the second bullet point. Parent is a U.S. citizen, and creates a grantor trust. Parent is the owner of the trust as defined in IRC §671. Child is the beneficiary. Child renounces U.S. citizenship and is a covered expatriate.

The portion of the trust owned by Child is 0%, because Parent owns 100% of the trust. The portion not owned by Child (i.e., 100% of the trust) is a nongrantor trust.

Implications for the Covered Expatriate

If a covered expatriate receives a distribution from a nongrantor trust (including a grantor trust owned by someone else), you have to deal with:

Withholding requirements imposed on the trustee (IRC 877A(f)(1)(A));
Gain recognition triggered for the trust by the distribution (IRC 877A(f)(1)(B)); and
Form W-8CE delivery to the Trustee (Notice 2009-85, Sections 7.C., 8).