Israel Changes Its Tax Law To Include The Taxation Of Many U.S. Trusts

Author:Ms Julie Goldstein
Profession:Fox Rothschild LLP

For many years, Israel has not taxed Israeli residents on any distributions they received from trusts created by a U.S. person with a U.S. trustee unrelated to the beneficiaries; beneficiaries were not even required to report such distributions.  This all changed when the Israeli Knesset passed its recent tax reform law, effective January 1, 2014, subjecting many previously tax-exempt trusts to significant Israeli income tax liability.  The reporting and tax obligations discussed below are imposed even if there are no assets in Israel, no trustee in Israel and the settlor is not an Israeli resident.

According to the new law, an Israeli Beneficiary Trust is a trust under which all settlors are foreign residents, and there is at least one Israeli resident beneficiary.  While all trusts in this category will now be taxed, those that can be classified as a Relatives Trust (sometimes referred to as a Family Trust) - when the settlor is the parent, grandparent, spouse, child or grandchild of the beneficiary - have an option that presents the more complicated tax-planning issue.

Trustees of existing Relatives Trusts must notify the Israeli tax assessor of the existence of such trusts by January 28, 2014 (or within 60 days of the creation of a new Relatives Trust).  Then, the Trustee must choose between two possible taxation regimes.  Under the Deferred Tax Regime, the Israeli resident beneficiary is taxed at a 30% rate upon distributions when received, while there is no yearly tax at the trust level.  Note that only income, not principal, is subject to taxation, but there is a presumption that income is distributed before principal.

The Trustee may make an irrevocable election...

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