Tax Compliance of The Bridge Trust®

Trusts come in many forms with many different taxation options. However, there is one special type of trust which is not only the most common, but also the most often misunderstood.  That is the "Grantor" Trust.

The Bridge Trust^® is an innovative legal tool designed for the management and preservation of family wealth which is specifically drafted under the Grantor Trust rules to be a grantor trust.  The purpose is tax simplicity and economy.  The benefits of the trust are many and include:

• Asset protection
• Tax neutrality
• Grantor retention of asset ownership
• Income is taxed directly to the settlors (or Grantors)
• No separate tax return (normally)
• No IRS filing requirements (normally)

The Bridge Trust^® has a proprietary design that creates a protective conduit to another jurisdiction for Trust assets in the event they are threatened from a creditor, lawsuit or other attack.  Prior to a threat that would “trigger” the protective features, the trust remains virtually invisible and maintenance free.  The protections and tax simplicity are accomplished through the following 4 features:

• The Trust has extensive Spendthrift Provisions. Spendthrift provisions are conditions that limit a beneficiary’s access, and a creditor’s rights, to trust property.
• The Trust is Irrevocable. Irrevocability prevents a court from ordering a settler to revoke the trust for the benefit of a creditor and thereby defeat the protective spendthrift provisions.
• The Trust is a Grantor Trust, allowing it to be completely disregarded as a separate tax entity.
• The Trust is Bridged. Prior to any threat to trust assets, the BT is considered Domestic for all purposes. If a specified Event of Duress occurs (such as a lawsuit) the trust may be “triggered” and cross the bridge to become a foreign trust governed by the laws of another country.

This last part is what makes up the “Bridge” component of the trust since the Trust is able to cross-over from the U.S. jurisdiction to the appropriate foreign jurisdiction in the event of a serious threat.

By combining these 4 unique attributes, Lodmell & Lodmell’s Bridge Trust^® gives clients all the protection of an irrevocable spendthrift trust with the ease and tax simplicity of a simple Revocable Living Trust.

The key is the Grantor Trust status.  The details of what makes a “Grantor” trust as defined by the I.R.S. includes the following distinctions:

• Any trust over which the grantor or other owner retains the power to control or direct the trust's income or assets.
• If a grantor retains certain powers over or benefits in a trust, the income of the trust will be taxed to the grantor, rather than to the trust. For example:
  1. the power to decide who receives income
  2. the power to vote or to direct the vote of the stock held by the trust or to control the investment of the trust funds
  3. the power to revoke the trust
• All "revocable trusts" are by definition grantor trusts.
• An "irrevocable trust" may be treated as a grantor trust if any of the grantor trust definitions contained in Internal Revenue Code §§ 671, 673, 674, 675, 676, or 677 are met.
• If a trust is a grantor trust; then
  1. the grantor is treated as the owner of the assets,
  2. and the trust is disregarded as a separate tax entity, and
  3. all income is taxed to the grantor.

At times confusion arises with accountants and attorneys who are unfamiliar with trusts combining irrevocability with grantor status.  The Bridge Trust^® is unique, therefore it is understandable that this mistake is sometimes made.

An irrevocable trust is one which, by its terms, cannot be revoked. For tax purposes an irrevocable trust can be treated as a simple, complex, or grantor trust, depending on the powers listed in the trust instrument. A revocable trust may be revoked and is always considered a grantor trust (IRC § 676). State law and the trust instrument establish whether a trust is revocable or irrevocable. If the trust instrument is silent on revocability, then most states consider the trust revocable.

In the case of the Bridge Trust^®, we specifically state that the irrevocable Bridge Trust^® is to be treated as a grantor trust for all tax purposes.  Further, the Settlors have retained control of the Trust as the Trustees as well as have retained a power of appointment, both of which qualify as certain powers as defined above. In the event that the trust were to need to be triggered and become a foreign trust, the grantor trust status would nevertheless remain. The trust would be considered a foreign grantor trust, thus retaining all of the tax benefits and simplicity. 

When a Bridge Trust is triggered, the trust would have additional foreign trust reporting requirements including IRS Form 3520, 3520A, as well as be required to file a 1041 trust tax return, and potentially other disclosures. These are informational to the IRS only and no additional tax is required but are critical. (The 3520 is required once the Trust becomes foreign and significant penalties apply for failure to file).

Treasury Regulations § 301.6109-4(b)(2) provide that a grantor trust which is treated as owned by a single person does not need to obtain a taxpayer identification number if the trustee uses the SSN of the grantor.  Accordingly, a separate tax return for the Trust per Treasury Regulations § 1.671-4(b)(2) provides that a separate return is not required (form 1041/1099) for a grantor trust that is treated as owned by a single person if:

• Trustee uses the SSN of the person treated as owner (grantor) for the trust, and
• The trustee is informed that all items of income, gain or loss are accounted for by the person treated as the owner of the trust (grantor).

If the trust grantors are married spouses, then Treasury Regulations § 1.671-4(b)(8) allow the Trust to treat the couple as one grantor if they file a joint tax return. These simplified reporting requirements are specific to both your trust as well as your particular situation, and the final determination as to the ability of your Bridge Trust to use the simplified reporting should be made by your CPA.

There are a few notable exception where a Grantor Trust cannot use these simplified reporting requirements and must obtain a taxpayer identification number and file a separate 1041 trust tax return:

1. If the Trust is going to hold any S-Corp assets and be qualified as a Subchapter S Corporation, then pursuant to Treasury Regulations § 1.671-4(b)(6)(iii) a QSST Trust must file a separate return.
2. If a married couple are both grantors on the Bridge Trust, but they file separately.
3. If the Trust opens a foreign bank account it must obtain a separate EIN and file a separate 1041 return, as well as make all applicable FATCA filings.

The Bridge Trust^® provides strong Asset Protection without adding the expense and hassle of the onerous tax reporting burden of a fully foreign trust. 

**Please see attached for the American Bar Association primer on Grantor Trust IRS reporting requirements.