The 5 Most Common Mistakes for Trusts Involving U.S. Citizens Living in Israel

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The 5 Most Common Mistakes for Trusts Involving U.S. Citizens Living in Israel




When establishing a trust involving U.S. citizens living in Israel, navigating both countries’ legal and tax nuances becomes paramount. The complexities of dual citizenship estate planning necessitate careful consideration of various factors to ensure the trust operates effectively and complies with both jurisdictions’ laws and tax obligations. These are the five most common mistakes I see people make, which can cost them heavily, and how to avoid them.


Understanding Dual Tax Ramifications


The first step in establishing a trust involving U.S. citizens living in Israel is to understand the tax implications in both countries thoroughly. Trusts, especially those with international ties, can trigger complex tax consequences, including income, estate, and gift taxes. Since 2014, Israel has been heavily developing trust rules and taxing trusts more carefully. Often, having one Israeli resident may make the whole trust an Israeli trust, necessitating reporting the total trust income in Israel.

At the same time, for U.S. purposes, there are meticulous rules about whether a trust is a U.S. or foreign trust. The difference is not just in name but also in how the taxes work for each. For example, suppose you set up a trust for U.S. citizen benefits in Israel, and it is considered a foreign trust, but you do not account for it correctly. In such a case, the beneficiaries can end up paying taxes on the principal contributed, not just the trust’s income. When setting it up, careful analysis of the laws must consider laws in both countries.


Reporting Requirements in the U.S. and Israel


Transparency is vital when dealing with trusts across borders. The U.S. and Israel have strict reporting requirements for foreign trusts and assets held abroad. Many U.S. citizens make Aliyah and don’t think about reporting their trust in Israel. The grantor, trustee, and income may all be in the U.S. However, your presence in Israel can create a reporting requirement there. If you haven’t reported the trust in previous years, there are ways to come into compliance. Those moving to Israel who are part of a trust should discuss it with an Israeli accountant to ensure they report everything correctly. 

In the U.S., a similar situation applies to states. If the trustee or property is in a specific state, there may be a state filing requirement. Even if everyone is now in Israel, if the trust was set up in a particular state, there may still be a state filing requirement, which is essential to keep in mind.


Strategic Trust Location and Trustee Selection


Jumping off the last point, the jurisdiction in which a trust is established, and the residency of the trustee can significantly impact the trust’s tax treatment and legal standing. For trusts involving U.S. citizens in Israel, a US-based trust is often advisable to simplify compliance with U.S. tax laws. Additionally, selecting a trustee who is a U.S. person can help avoid adverse tax consequences and facilitate the trust’s administration.

However, it’s essential to ensure that the trustee does not reside in a state with unfavorable trust laws or tax rules that could negatively impact the trust. For example, many use a California trustee when the assets are solely a brokerage account, and the beneficiaries are based in Israel. By doing this, you are adding California taxes onto the income, which may be unnecessary if you can switch the trustee.

At the same time, many in Israel will set up a trustee who is not a U.S. citizen. This has significant ramifications for the trust’s reporting and taxation for U.S. tax purposes. The choice of trustee is a choice that needs considerable due diligence before executing the trust and its ongoing maintenance.



Documenting the Purpose of the Trust


Trust documents can be lengthy and include many different clauses for various purposes. For example, does the trust document include a Crummey provision? Is it treated as a grantor, complex, or simple trust? Is it revocable or irrevocable? All of these items can be buried in pages and pages of legal jargon that is not understandable to humans.

I have seen some lawyers create a summary document, an incredible supplement to the trust documents. A clear and comprehensive summary of the trust’s original purpose is invaluable. This document should outline the grantor’s intentions, the trust’s objectives, and the reasons behind its establishment. This summary can guide trustees and beneficiaries, ensuring the trust remains aligned with the grantor’s goals and adapts to changing circumstances while maintaining its core purpose.

Additionally, this helps with another core issue. Tax laws often change, and the reason for the trust setup can no longer be applicable. At the same time, no one who remains understands why the trust was set up in the first place. Instead of knowing if it is the right time to disband the trust, they assume there is a good reason for its continued existence while accumulating considerable costs and taxes. If the trust’s purpose no longer exists, and you have the reasons written out clearly, it can help make better decisions. 


Proper Trust Administration and Distributions


Effective trust administration is vital to fulfill the trust’s objectives and maintain its legal and tax standing. This involves managing the trust’s assets according to the terms set out by the grantor, making distributions to beneficiaries as specified, and ensuring all actions taken by the trustee are in the best interest of the beneficiaries and in compliance with relevant laws. We often receive trust returns prepared by other accountants who never viewed the trust documents or discussed distributions with the trustees or beneficiaries.

Many of them are labeled as simple or complex trusts with full distributions on the tax returns. However, when asking if any real distributions were made, the answer is usually a quizzical “No, why?”. If a trust is supposed to distribute a specific percentage of income or amount per year, it is crucial that they are actually distributed.

The IRS allows for some distributions to be made post-year-end to ensure you can know the trust’s total income before making any necessary distributions. However, it is crucial to do so within 65 days post-year-end and that the tax returns connect with reality. The reality should also follow the trust documents. Too often, this is not done correctly, putting the whole trust at risk. At the same time, Israel may not allow this grace period, so it is important to align these two together so the two countries’ reporting doesn’t mismatch, ending with double taxation.


Regular reviews and audits can help ensure the trust is being administered correctly and that distributions, if applicable, are being made correctly.


How best to avoid similar mistakes?


For U.S. citizens living in Israel, establishing and managing a trust requires careful planning and ongoing diligence to navigate the complexities of dual jurisdictions. By focusing on tax ramifications, compliance with reporting requirements, strategic setup, clear documentation of the trust’s purpose, and meticulous administration, you can ensure the trust serves its intended purpose effectively and efficiently.

If you’re a U.S. citizen in Israel considering setting up a trust or needing assistance with an existing one, we’re here to provide expert guidance. Contact us to explore how we can help you navigate the complexities of U.S.-Israel trust planning and administration.


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