Calculating Foreign Trust DNI and UNI: Avoiding Throwback Tax on Undistributed Net Income

Description

Calculation of trust accounting income and the tax concept of distributable net income (DNI) in domestic trusts is one of the more complicated tasks in both fiduciary and tax accounting and can be even more daunting with foreign trusts involving U.S. persons. In general, a U.S. taxpayer who either creates a foreign trust, transfers or receives money or property from a foreign trust, or is the U.S. owner of a foreign trust, is subject to tax requirements.

While foreign non-grantor trusts are not usually subject to U.S. income tax on non-U.S.-sourced or effectively connected income, U.S. beneficiaries are subject to income tax on distributions made out of the trust’s DNI.

IRC 643 provides that all income earned by a complex foreign non-grantor trust is DNI. However, the throwback rules require that, unless current DNI is distributed within 65 days of the tax year’s end, the DNI must be reclassified as UNI rather than being treated as an addition to trust corpus.

U.S. beneficiaries receiving distributions from foreign trusts more than DNI in a given year must pay an “accumulation” or throwback tax, plus interest, on that portion of the distribution classified as UNI. This throwback tax can equal the entire amount of the accumulation distribution. Given the steep tax consequences to both trusts and U.S. beneficiaries of having UNI, tax advisers need to thoroughly understand the special rules involving DNI calculations on foreign trusts.

Listen as our expert panel provides practical guidance for navigating rules on calculating DNI and UNI in foreign trusts.