MSTR Cat

Trust Law/Level VIII · Trusts of the world/8.1 Common-law systems/Lesson 7

Choosing governing law and situs

How a trust’s governing law, place of administration and forum differ, how US and Hague rules let them be chosen or changed, and how US federal tax residence is decided.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Cheapest default: keep governing law, trustee and administration in one home state, so nothing moves. Catch: a non-grantor trust there faces that state’s tax unless an exemption fits, such as New York’s for trusts with no New York trustee, property or source income.
  2. To move situs without court, a UTC trustee may transfer the principal place of administration after at least 60 days’ notice to qualified beneficiaries (§108). Catch: a timely objection by any qualified beneficiary ends that power, leaving a costlier court application.
  3. Choose the governing law expressly: UTC §107 honours it unless contrary to a strong public policy of the most significant jurisdiction, and Hague Article 6 honours a chosen law that has trusts. Catch: otherwise Article 7’s closest-connection test decides.
  4. Keep US tax residence: a US court must be able to supervise and US persons must control all substantial decisions (Treas. Reg. §301.7701-7); an accidental change can be cured within 12 months. Catch: a trust turning foreign is taxed as selling its assets (IRC §684).
  5. Foreign trust status brings costly reporting: failing to file Form 3520 can cost the greater of $10,000 or 35% of the gross reportable amount, and Form 3520-A failures 5% (IRC §6677). Catch: these penalties apply even when no tax is due.

MaterialsUniform Trust Code §§107 and 108 as enacted in a state, such as Maine Revised Statutes title 18-B, free on the legislature’s websiteHague Trusts Convention, Articles 6 to 10, free on the HCCH websiteTreas. Reg. §301.7701-7 (the court test and the control test), free on the Cornell Legal Information Institute website

Wonder

  1. Can a trust be governed by one state’s law while it is administered in another?
  2. What happens if a settlor chooses the law of a country that has no trusts?
  3. Why can replacing a trustee turn a US trust into a foreign trust for tax purposes?

Explore

  1. Three ideas are often confused. The governing law is the law that determines a trust’s validity, meaning and effect. The place of administration, often called the situs, is where the trust is actually run, usually where the trustee is based and keeps records. The forum is the court that hears a dispute. They can coincide but need not: a trust may be governed by one state’s law, administered by a trustee in another and litigated in a third. Moving one does not automatically move the others, unless the trust terms or the applicable law link them. This lesson explains the rules and does not recommend any jurisdiction.
  2. In the US, the Uniform Trust Code (UTC), enacted in some form in about 36 states and the District of Columbia, addresses governing law in §107. The meaning and effect of a trust’s terms are determined by the law of the jurisdiction designated in the terms, unless the designation is contrary to a strong public policy of the jurisdiction having the most significant relationship to the matter at issue. Without a controlling designation, the law of the jurisdiction with the most significant relationship applies. States do not always enact the uniform text word for word; Kansas, for example, words the exception differently, so each state’s enacted version matters.
  3. UTC §108 deals with the principal place of administration. A term designating it is valid and controlling if a trustee’s principal place of business is located in, or a trustee is a resident of, the designated jurisdiction, or if all or part of the administration occurs there. The trustee has a continuing duty to administer the trust at a place appropriate to its purposes, its administration and the interests of the beneficiaries, and may transfer the principal place of administration to another state or to a country outside the US. The trustee must notify the qualified beneficiaries at least 60 days in advance; a timely objection by a qualified beneficiary ends the trustee’s power to transfer under the section, though a court may still order or approve a transfer.
  4. The US has not ratified the Hague Trusts Convention (concluded 1985, in force 1992), but it sets the choice-of-law rules in countries that have (lesson 1.2.7). Under Article 6, a trust is governed by the law chosen by the settlor, expressly or by implication; if the chosen law does not provide for trusts or the category of trust involved, the choice is not effective and Article 7 applies. Article 7 points to the law with which the trust is most closely connected, considering in particular the place of administration designated by the settlor, the situs of the assets, the trustee’s residence or place of business, and the trust’s objects. Article 9 lets a severable aspect, particularly administration, be governed by a different law, and under Article 10 the law governing validity decides whether the applicable law may be replaced.
  5. For US federal income tax, Treas. Reg. §301.7701-7 treats a trust as a United States person, a domestic trust, only if it meets both tests on that day: the court test, under which a US court is able to exercise primary supervision over the trust’s administration, and the control test, under which one or more US persons have authority to control all substantial decisions of the trust. Every other trust is a foreign trust. Substantial decisions include, for example, decisions about distributions and about removing or replacing trustees, so giving such a power to a non-US person can make a trust foreign. After an inadvertent change, such as a trustee’s death or resignation, the regulation allows 12 months to make changes and avoid a change of residence. State income tax residence is a separate question.
  6. Practitioners describe several reasons a trust may move its place of administration or change its governing law, where the terms or the applicable law allow: to reduce state income tax, to use another state’s rules on duration, directed trusts or decanting (lesson 8.1.5), to follow a trustee or family that has moved, or to reduce administrative cost. Moves have limits. The trust instrument may restrict them, beneficiaries may object under UTC §108, a change of trustee can alter federal tax residence, and courts may still apply another jurisdiction’s law to some questions, such as the claims of a settlor’s creditors. Whether a move achieves its aim depends on the facts and the laws involved.

Key facts

  • A trust’s governing law, place of administration (situs) and forum are distinct and need not coincide.
  • UTC §107 applies the law designated in the trust terms unless it is contrary to a strong public policy of the jurisdiction with the most significant relationship to the matter.
  • UTC §108 lets a trustee transfer the principal place of administration after at least 60 days’ notice to qualified beneficiaries; a timely objection ends that power, subject to the court.
  • Under Hague Convention Article 6, a chosen law that does not provide for trusts or the category involved is not effective, and Article 7’s closest-connection test applies.
  • Hague Convention Article 9 allows a severable aspect of a trust, particularly administration, to be governed by a different law.
  • Under Treas. Reg. §301.7701-7, a trust is a US domestic trust only if it meets both the court test and the control test.

Exercise nine, six, three, one

9CollectList up to 9 connections between a trust and a place, from this lesson or a trust instrument you are reading (some sources give fewer), such as the chosen governing law, where the trustee lives, where records are kept, where assets are located and which court has heard disputes.
6ClusterSort them into 6 categories: governing law, place of administration, forum, location of assets, tax residence, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: connections chosen in the trust terms, connections that follow from the trustee, and connections that follow from the assets or the courts.
1CrystallizeWrite 1 sentence explaining, in your own words, why changing a trustee can affect both a trust’s place of administration and its US tax residence.

Fact check

Dates, figures and claims checked against the published sources listed below.

Open in the interactive academy →

PT ES ZH JA KO RU DE FR MS