U.S.-Trusts in German-American Estate Planning

U.S.-Trusts in German-American Estate Planning

Trusts are a fundamental component of traditional estate planning in common law jurisdictions. Yet, they are virtually unknown in German Civil law. Following the introduction of regulations drafted to target tax avoidance in 1999, the German government enacted tax provisions applicable to transfers to certain trusts. This article describes the legal framework applicable to common law trusts and provides recommendations for the avoidance of tax traps associated with German tax law.

Trusts in German Civil Law

Trusts are virtually unknown in German Civil law and German land law does not allow for the transfer of assets located in Germany to a trust. However, such a transfer does not necessarily have to be without effect. For example, a testamentary trust may be interpreted as a German legal instrument which has similar effects. For example, it may be interpreted as durable execution of the estate (Dauertestamentsvollstreckung), subsequent heirship (Vor- und Nacherbschaft), life estate / usufruct (Nießbrauch) or a combination thereof.

Basic Principles of the German Inheritance and Gift Tax Act

The taxation of estates and gifts in Germany is codified in the German Inheritance and Gift Tax Act (ErbSt). Additionally, other German tax laws, such as the German General Fiscal Code (AO) and the Valuation Act (BewG) contain relevant provisions. Finally, the Germany-U.S. Estate and Gift Tax Treaty may be applicable. 

Nature and Calculation of the German Inheritance Tax

In contrast to U.S. federal estate tax law, German inheritance tax (Erbschaftsteuer) does not attach to the estate itself, but instead the acquisition of each beneficiary is taxed. Tax rate and tax free exemptions depend on the familial relationship between the deceased and the beneficiary. Tax free exemptions are granted per capita.

Estate Planning Consideration: If more than one family member lives in Germany, consider making distributions to each of them individually as the tax free amount is granted per capita.

There is no generation skipping tax in Germany.

Estate Planning Consideration: If there is more than one generation living in Germany, consider skipping one generation.

For more information on the German inheritance tax please see our article “The German Inheritance Tax”.

Tax liability in Germany

Germany taxes all worldwide transfers, if either the beneficiary or the deceased is a German tax resident (Inländer) at the time of his death (§ 2 ErbStG). For more information on the German inheritance tax please see our article “The German Inheritance Tax, Secion Taxable Transfers in Germany”.

Please note: If the decedent`s domicile at the time of death was in Germany, the U.S. or in both countries, the “fiscal domicile” of the decedent, donor or beneficiary is determined under Art. 4 of the Germany-U.S. Estate and Gift Tax Treaty

Special Provisions for the Taxation of Trusts 

Pursuant to traditional German Civil Law analysis, the  German Inheritance and Gift Tax Act did not recognize trusts as legal entities until 1999. Following the introduction of regulations drafted to target tax avoidance in 1999, the German government enacted special provisions treating trusts as legal entities for inheritance and gift tax purposes.

Transparent Trusts and Non-Transparent Trusts

The special rules available to trusts are only applicable if control is released by the Grantor. If the trustee is, from a German perspective, a mere agent of the Grantor (or the beneficiary) the rules described above will not be applicable. Specifically, if the Grantor has the right to the following, the trust will not be deemed a legal entity and any transfer to the trust will not be taxed:

  • To change the trust document at any time;
  • To revoke the trust at any time; and
  • To give the trustee instructions with respect to the management of the trust assets and the distribution to the beneficiaries (or he is the trustee himself).

Should the Grantor lose the requisite control of the trust assets (e.g. following the creation of the trust through death) and the (successor) Trustee holds the trust assets in favor of a beneficiary without being obliged to distribute the trust assets to the beneficiaries without delay (like an executor or administrator), the trust is a deemed legal entity for inheritance and gift tax purposes. 

All trusts that are not deemed to be legal entities under German tax law are referred to as “transparent trusts” hereinafter. If not explicitly stated otherwise, the following only applies to non-transparent trusts.

Taxation of Asset Transfers to Inter Vivos Trusts

Pursuant to § 7 Section 1 Lit. 8, Sentence 2 ErbStG, transfers of assets to a trust that is deemed a legal entity for tax purposes, trigger German gift tax (Schenkungsteuer). There is a nexus to Germany, if either the Grantor or the Trustee is domiciled in Germany at the time of the transfer. If only the beneficiary is domiciled in Germany, no German gift tax is triggered by the mere fact of transferring the assets to the trust.

Example: Grantor A, U.S. citizen, without a fiscal domicile in Germany, transfers € 500,000 into an irrevocable living trust and does not retain any rights with respect to the trust assets. The Trustee is fiscally domiciled in the U.S. Despite the fact that the beneficiary resides in Germany, the transfer is not taxable in Germany.

If the transfer is taxable in Germany, the asset transfer is subject to least favorable tax class III, which provides for a minimal € 20.000 tax-free allowance and tax rates from 30% to 50%.

Example: Grantor A transfers € 500,000 to an AB Trust, which is managed by the trustee who is fiscally domiciled in Germany. Upon transfer of the assets to the trust, a tax base of € 480,000 would be found resulting in a tax assessment of € 144,000. Calculations: Taxes payable at transfer: Transfer to the Trust = Taxable acquisition of the trust: €500,000 Tax allowance under § 16 ErbStG: - €20,000 Tax Base: €480,000 Application of tax rate according to § 19 ErbStG (x 0.3) = Tax Due: € 144,000

Taxation of the Transfer of Assets to a Trust upon Death of Settlor of Revocable Trust

If a non-tax-transparent trust is created upon the death of the grantor (e.g. because a revocable trust becomes irrevocable and the successor trustee shall hold and administer the trust assets for the lifetime of a beneficiary) and the trust has a nexus to Germany, German inheritance tax is triggered. See § 3 Section 2 lit 2 ErbStG. There is a nexus to Germany, if either the Grantor or the Trustee is domiciled in Germany at the time of the creation of the trust. If only the beneficiary is domiciled in Germany, no German gift tax is triggered by the mere fact of transferring the assets to the non-tax-transparent trust.

Estate Planning Consideration: This may be used to avoid the German inheritance tax if the beneficiary does not permanently lives in Germany and considers to return to the U.S.

However, the Trust income may be attributed to a German resident beneficiary if the trust is a “family trust” in the meaning of § 15 of the Foreign Transaction Tax Act (AStG) contain relevant provisions. AStG. A trust is a “family trust” in the meaning of German tax law, if the Grantor, his close relatives or their offspring are beneficiaries of at least 50 % of the trust assets. The taxation imposed on the beneficiary is irrespective of whether the income is reinvested or distributed to the beneficiary.

If the successor trustee shall distribute the trust assets outright and free of trust to the beneficiaries, the trust is tax transparent and the interest of beneficiary is subject to German inheritance tax. 

Example: Grantor A, U.S. citizen, without a fiscal domicile in Germany, transfers € 500,000 into a revocable living trust and retains the right to revoke and amend the trust. Upon his death, the trust become irrevocable and German inheritance tax is triggered (for calculation of the tax see prior example).

Taxation of Distributions during the Existence of the Trust

Distributions during the existence of the trust are subject to German gift tax under § 7(1) Nr. 9, S 2 ErbStG (see decision of the German Federal Fiscal Court (Bundesfinanzhof) dated 27th September 2012, file number II R 45/10). The tax class is determined by the familial relationship between the Grantor and the beneficiary. See § 15 (2) S. 2 ErbStG

In addition, distributed trust income is subject to German income tax under § 20 (1) No. 9 of the German Income Tax Act (EStG) unless already attributed to the German beneficiary.  In our opinion distributed trust principle is not subject to German income tax. Unfortunately, the German tax court has not rendered a decision on this matter and, there remains a risk that a tax authority opines otherwise.

Taxation of Final Distribution (Dissolution of Trust)

The final distribution of trust assets to beneficiaries is subject to German gift tax under § 7 (1) Nr. 9 S. 2 ErbStG. The applicable tax class is determined by the familial relationship between the Grantor and the beneficiary. See § 15(2) Nr. 2 ErbStG. Any distribution within the 10 years preceding the final distribution is added to the taxable acquisition for the calculation of the tax. See § 14 ErbStG

Example: In 2001, Grantor A transfers €500,000 to an AB trust (tax consequences, see example above). The trustee is T, a professional trust manager residing in Germany. Under the terms of the trust instrument T is free to administer the trust assets. The income of the trust (€100,000) is distributed to the A`s son B during the lifetime of A. Upon the death of A, the trust assets are distributed to A´s son, B (beneficiary). Final distribution (€500,000) + Distributions to B in the last 10 years (€100,000) = Total taxable acquisition: € 600,000. Tax base after deduction of tax allowance (€400,000) = € 200,000; Tax due (see tax table): € 22,000

Election Right under the German-American Estate and Gift Tax Treaty

Under Art. 12 (3) of the Germany-U.S. Estate and Gift Tax Treaty the beneficiary of a trust may elect to be subject to all German taxation (including income taxation) as if a taxable transfer had occurred to him at the time of such transfer and not to the trust provided that

  • the transfer to the trust did not trigger German inheritance or gift tax and
  • the election is made within five years after the transfer to the trust. 

Recommendations

  • If the Grantor has a fiscal domicile in Germany it is generally not advisable to create a trust that is deemed to be a legal entity under German tax law.
  • A trustee who has a fiscal domicile in Germany should not be named if the trust is deemed to be a legal entity under German tax law.
  • If the Grantor`s fiscal domicile is in the U.S. and the beneficiary`s fiscal domicile is Germany, the creation of a trust that is not transparent under German law may be advantageous if the beneficiary may later move back to the U.S.
  • If more than one family member lives in Germany, consider making distributions to each of them individually as the tax free amount is granted per capita.
  • If there is more than one generation living in Germany, consider skipping one generation. There is no generation skipping tax in Germany.
  • Do not transfer German assets to a trust. Trusts are not recognized by German civil law and any transfer to a trust may complicate estate administration.
  • If the beneficiaries are minors or there is any other reason to retain rights in the estate, use German legal instruments that are similar to a trust in replacement of a trust
Rate this article
 
 
 
 
 
 
 
9 Rates (100 %)
Rate
 
 
 
 
 
 
1
5
5
 

Do You have any Questions?

We look forward to assisting you. For the sake of simplicity and efficiency, we request that you use our contact form for your inquiry and describe the matter as clearly as possible. In addition, you can include relevant attachments. After submitting your inquiry, we will contact you either by telephone or e-mail within one working day. If we can assist, we will suggest a time and date for an initial consultation. Of course, you can also contact this firm or a particular attorney directly to make an appointment for a personal consultation or telephone consultation (find contact details here). Please be advised that no attorney-client relationship is created by sending us an email or filling out this contact form. For information on our fees, please click here.  

Formular
captcha
Attach documents to your message to us (max 5 MB).