An Overview Concerning Certain Recent Changes for Foreign Compensatory Trusts: 402(b) Trusts, Grantor Trusts and "Rabbi" Trusts

Abstract

Foreign companies and their U.S. subsidiaries employing U.S. persons have devised a wide range of executive and other deferred compensatory arrangements in order to be an incentive to their workforce. Because of matters relating to administrative ease, or in some cases, certain foreign legal or accounting issues, these incentive awards are often contributed to trusts by foreign employers or foreign parents of U.S. employers, and most notablyforeign trusts described in section 7701 (a)(3 1).Under the Code, special rules govern the U.S. federal income taxation of trusts. In particular, under sections 671 through 679, a grantor of a trust who retains certain powers over or interest in the trusts is treated as the "owner" of the trust, with the result that all of the trust's income is taxable to the owner. Certain special vehicles, so-called "rabbi trusts," whose assets are subject to the claims of creditors of the employer, are also subject to these rules. Additionally, under section 402(b), certain compensatory trust arrangements result in a separate level of tax on the trust entity, along with the additional result that participants are often taxed on their vested interest in the trust.In 1996, the Small Business Job Protection Act amended portions of sections 672 and 679, among others, and in September of 1996, and again in June of 1997, the Internal Revenue Service (the Service) issued proposed regulations which dramatically affect the foreign trust deferred and incentive compensatory world. In February 1999, and again in August 1999, the Service issued certain final regulations affecting foreign trusts. The cumulative effects of the statutory and regulatory changes are broad, involving changes in the treatment of both "inbound" and "outbound" compensatory trust arrangements.