U.S. Trusts: Taxation in Germany

U.S.-Americans relocating to Germany often bring more than just their children and family. They frequently also bring interests in U.S. LLCs and/or claims against a U.S. trust. This article focuses on the tax risks associated with U.S. trusts, commonly established in the USA for succession planning. The tax pitfalls of shareholdings in U.S. LLCs have been discussed here.

In the Anglo-American understanding of law, trusts are foreign to German law. Therefore, U.S. trusts are not recognized as independent legal entities in Germany. The tax treatment of a U.S. trust in Germany depends on its specific contractual structure. Thus, not all trusts are equivalent:

1. A transparent trust exists if the settlor of the trust retains control over the transferred assets. This is especially the case if the settlor reserves the right to revoke the trust assets (revocable trust). Such a trust is not recognized for tax purposes, and the transferred assets are attributed to the persons “behind the trust”. If the settlor of the U.S. trust passes away, the trust assets transferred are attributed to the deceased’s total assets, not to the U.S. trust itself, for the purposes of determining German inheritance tax, to the heir’s detriment.
2. The situation differs with an irrevocable trust. Such a trust is a non-transparent trust to which the assets transferred are exclusively attributed. Unlike a revocable trust, such a trust does not have a revocation right regarding the trust assets.

The irrevocable trust carries the most significant tax risks, which is why only such trusts are discussed below.
 

Generally, distributions from U.S. trust assets are capital gains (Section 20 (1) no. 9 German Income Tax Act, EStG). These are subject to a capital gains tax of 25 percent for a domestic beneficiary.

Distributions from a U.S. trust to a beneficiary with unlimited tax liability in Germany may be subject to gift tax in addition to income tax (Section 7 (1) no. 9 German Inheritance Tax Act, ErbStG). This applies if the domestic beneficiary is an intermediate beneficiary. An intermediate beneficiary is someone who has a claim to the distributions from the U.S. trust, irrespective of a specific distribution resolution. Beneficiaries of a discretionary trust, where the trustee has the discretion of whether, when and to whom distributions are made, do not meet this definition.
 

Even if the domestic beneficiary does not receive any distributions from the trust, income can be directly attributed to him personally at the level of the trust assets in accordance with his participation in the U.S. trust (Section 15 of the Foreign Tax Act, AStG). These so-called Controlled Foreign Corporation (CFC) Rules tax income that has not actually accrued to the taxpayer. In addition to the resulting liquidity problems, beneficiaries must expect a significant administrative burden, as the entire income of the U.S. trust must be determined and disclosed to the German tax authorities.

Family foundations and trusts domiciled in EU or EEA member states are exempt from this extensive CFC taxation under certain conditions.
 

Distributions that accrue to the beneficiary as part of the liquidation of a U.S. trust are also subject to capital gains tax as investment income. However, only increases in value that have accrued at the level of the U.S. trust since December 8, 2010 are taxed.

Compared to current distributions, these distributions are always subject to gift tax when the U.S. trust is terminated. However, the so-called tax class privilege applies to such donations (Section 15 (2) ErbStG). This means that a more favorable tax class with a tax-free allowance of up to EUR 400,000 can apply if the trust deed is drafted correctly.