“Whenever engaging in trust planning with clients who wish to

Steve Leimberg's International Tax Planning Email Newsletter - Archive Message #39

Date:

05-Dec-22

From:

Steve Leimberg's International Tax Planning Newsletter

Subject:

Mary O'Reilly, Yair Benjamini & Shiran Polishuk: Israeli Income Taxes Lurking

in Your US Estate Plan

“Whenever engaging in trust planning with clients who wish to benefit

Israeli residents, extreme care should be taken to make sure the trust plan

does not unnecessarily trigger Israeli income taxes or reporting. In these

situations, the best practice is to consult with Israeli tax counsel to ensure

the trust is structured to minimize any Israeli income tax exposure.”

Mary O’Reilly, Yair Benjamini and Shiran Polishuk provide members

with commentary that examines the issues that should be considered when

doing trust planning on behalf of US citizens or residents who have

children, grandchildren or other beneficiaries who live in Israel. Members

who wish to learn more about this topic should consider watching this LISI

Webinar: Estate Planning for U.S. Persons Who Have Assets or

Descendants in Israel: What You Don’t Know Can Indeed Be Costly.

Mary O’Reilly is Co-Chair of the firm’s nationally recognized Trusts &

Estates Practice Group and a Partner in the Business & Real Estate

Taxation, Private Wealth & Taxation, Trust & Estate Litigation and Tax

Exempt Organizations Practice Groups at Meltzer, Lippe, Goldstein &

Breitstone, LLP. As an estate planning attorney to high net-worth

individuals and families, Mary not only provides advice regarding tax

planning, business succession and asset protection, but also serves as a

trusted advisor to some of the country’s wealthiest individuals and business

owners, who seek her advice and counsel on all aspects of their family,

finances and business interests. A frequent lecturer and writer in her field,

she speaks at prominent legal conferences across the country and has

written for leading industry publications such as Trusts & Estates

Magazine, ABA Probate & Property Magazine and Steve Leimberg’s Estate

Planning Newsletter. Mary has been recognized as a leading estate

planning attorney by various business publications including Chambers and

Partners, Crain’s New York and Long Island Business News. Mary received

her LL.M. (Masters of Law) in Taxation from New York University School of

Law and earned her J.D., cum laude, from St. John’s University School of

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Law in 2003, where she attended law school on a full academic

scholarship.

Yair Benjamini is a Partner at Benjamini & Co. Yair has worked in the

field of Israeli taxation for the last 20 years and over time has acquired

broad legal knowledge and extensive experience in all areas of Israeli

taxation, as well as in a wide range of complex international taxation

issues.

Shiran Polishuk is an Associate at Benjamini & Co. Shiran is an attorney

who specializes in Israeli and international taxation.

Here is their commentary:

EXECUTIVE SUMMARY:

Many United States citizens or residents have children, grandchildren or

other beneficiaries who live in Israel. When estate planning for these

clients, care must be taken to ensure Israeli income tax is not

unnecessarily triggered under Israel’s wide reaching trust taxation law that

took effect in 2014. Although the law was enacted by Israel to curb a

perceived abuse of Israelis using trusts to shelter income, its broad reach

can cause an Israeli income tax for trusts created by US residents where

the only connection to Israel is the residency of one beneficiary. This

includes trusts that are “grantor trusts” for US income tax

purposes. Unfortunately, the US/Israeli Tax Treaty does not always serve

to mitigate against this double taxation. As such, care must be taken

whenever a client creates a trust with an Israeli resident (an “Israeli”) as a

potential beneficiary.

COMMENT:

Identifying Trusts Subject to Israeli Income Tax

The Israeli income tax liability of a trust is based on the tax residency of the

Settlor (as defined below) and the Beneficiary or Beneficiaries (as defined

below) and the relationship between them. As such, the threshold issue in

determining whether a trust will be subject to Israeli income tax is

identifying the Settlor and the Beneficiaries. These rules are set forth in

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Chapter Four 2 of the Israel Income Tax Ordinance [New Version], 5721-

1961 (the “Ordinance”).

Who is a Beneficiary?

A Beneficiary is defined as a person that is “entitled to enjoy the assets or

income of the trust, either directly or indirectly.”[i] A Beneficiary includes a

person whose entitlement is contingent upon a condition, unless the

condition is the demise of the Settlor or another Beneficiary and such

Settlor or other Beneficiary is still alive. In other words, contingent

beneficiaries are considered “Beneficiaries,” except if the contingency is the

death of the Settlor or other Beneficiary who are still living. In that case,

the contingent beneficiary will not be regarded as a “Beneficiary” for

purposes of the Israeli tax.[ii]

Who is a Settlor?

A Settlor is defined as “a person that contributed, directly or indirectly, an

asset to a trust.”[iii] A contribution is a gift or bequest of an asset for no

consideration. This is in line with the concept of a “settlor” for US

purposes. However, under the Israeli law, a Settlor also includes “a

Beneficiary who is able to control or influence— directly or indirectly—the

manner in which the trust is managed, the trust assets, the designation of

beneficiaries, the appointment or replacement of trustees, or the

distribution of the trust assets or the trust income to beneficiaries.”[iv] Thus,

a Beneficiary of a trust may also be deemed a Settlor if he has control or

influence over the trust. This would include both a Beneficiary who is a

trustee of a trust and a Beneficiary who is not a trustee but who can exert

control over the trust in other capacities.[v]

Unfortunately, because the Israeli tax law is relatively new, there is little

guidance in the case law on what level of control a Beneficiary has that will

cause him to be a Settlor. Certainly, a Beneficiary acting as an investment

advisor or a distribution advisor of a trust would rise to the level of a

Settlor. However, less clear is whether a Beneficiary who is an officer or

director of a company owned by the trust would rise to the level of a

Settlor. As such care should be taken to analyze the role any Beneficiary

has in a trust to determine if he or she is also a Settlor.

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Once it is determined that a trust has at least one Settlor or Beneficiary

who is an Israeli resident, then next step in determining whether the trust

will be subject to Israeli income tax is identifying the type of trust. There are

five types of trusts for Israeli tax purposes, namely:

 Foreign Resident Trust[vi];

 Foreign Resident Beneficiary Trust[vii];

 Relative’s Trust [viii];

 Israeli Resident Beneficiary Trust[ix]; and

 Israeli Resident Trust[x].

Foreign Resident Trust

Not surprisingly, a trust where all Settlors and Beneficiaries are non-Israeli

residents in the current tax year is considered a Foreign Resident Trust so

long as the trust has never had an Israeli Beneficiary.[xi] However, as

explained above, a beneficiary whose interest in the trust is contingent up

on the death of a Settlor or a Beneficiary is not considered a Beneficiary for

purposes of the Israeli tax law.

Examples of Foreign Resident Trusts would include the following trusts:

 Trust created by a US resident where an Israeli grandchild is the

remainderman of trust after his US parent’s death. Since the Israeli

grandchild’s interest in the trust is contingent upon his parent’s death,

it is Foreign Resident Trust during the parent’s life.

 Marital QTIP trust created by a US resident for the benefit of US spouse

with trusts for Israeli children as the remainderman. Again, since the

Israeli children’s interest in the trust is contingent upon the death of the

surviving spouse, the trust is a Foreign Resident Trust during the life

of the surviving spouse.

 Revocable trust created by and for the benefit of the US resident that

passes to his Israeli children after his death, the trust is a Foreign

Resident Trust during the Settlor’s life.

A Foreign Resident Trust is treated like any other foreign resident under the

Israeli income tax law—meaning it will only be subject to tax in Israel on its

Israel source income. Additionally, Foreign Residents Trust are only

4882-5745-5694, v. 1

required to open a tax file with the ITA and file annual tax returns if the trust

holds assets situated in Israel or generates Israeli source income.

Foreign Resident Beneficiary Trust

A Foreign Resident Beneficiary Trust is an irrevocable trust where at least

one Settlor is Israeli but none of the Beneficiaries are Israelis, and the trust

agreement explicitly excludes Israeli residents from becoming a

Beneficiary. Thus, although a beneficiary whose interest is contingent on

the death of another Beneficiary is not considered a Beneficiary for general

purposes of the Israeli tax law, an Israeli having a contingent interest in a

trust it will disqualify the trust from being a Foreign Resident Beneficiary

Trust since at some point in the future an Israeli will be a Beneficiary. For

example, an irrevocable trust created by an Israeli for the benefit of their

US descendants only would be considered a Foreign Resident Beneficiary

Trust. This trust will remain a Foreign Resident Beneficiary Trust even after

the demise of the Israeli Settlor. If the Settlor becomes a non-Israeli

resident, and the trust has never had an Israeli Beneficiary then the trust

will convert from a Foreign Resident Beneficiary Trust to a Foreign

Resident Trust (described above).

Like a Foreign Resident Trust, a Foreign Resident Beneficiary Trust is

considered a foreign resident and will be taxed in the same manner in

which an individual foreign resident will be taxed—only on its Israeli

income. Thus, if the trust assets and income are non-Israeli sourced, there

are no income tax implications in Israel. However, the trustee of a Foreign

Resident Beneficiary Trust is also required to submit an annual report to

the ITA and notify it of any distribution made in the tax year, including the

names of the beneficiaries and the amounts distributed to them. Failing to

timely submit the annual report to the ITA results in a fine of 500 New

Israeli Shekels (“NIS”) in respect of each whole month of delay in

submitting the return.[xii] In addition, financial sanctions and interest may

apply.

Relative’s Trust

A Relative’s Trust is a trust where (i) one or more Beneficiaries are Israeli,

(ii) the trust has never had an Israeli Settlor, (ii) all the Beneficiaries are

“Closely Related” to all of the Settlors, and either the Settlor or his

spouse[xiii] is still alive. For these purposes, a Beneficiary is “Closely

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Related” to a Settlor if the Beneficiary is a child, grandchild, a spouse, a

parent or grandparent of a Settlor. If there is a family relation but it is more

distant relationship, namely, the Beneficiary is either: (i) a sibling of the

Settlor, (ii) a descendant (other than a child or grandchild) of the Settlor, (iii)

a descendant of the Settlor’s spouse, (iv) a spouse of any of the above, or

(v) a descendant of the Settlor’s sibling or a sibling of the Settlor’s parent

(each of (i)-(v) a “Distant Relative”), the trust may qualify as a Relative’s

Trust but it is not automatic. To qualify, the ITA must be convinced that the

establishment of the trust and the contributions to the trust were done in

good faith and that the Beneficiary paid no consideration for his or her right

in the trust’s assets.[xiv]

An example of a Relative’s Trust is a sprinkle trust created by a US

resident with his US spouse as the trustee for the benefit of his US

daughter and her descendants and his Israeli son and his descendants,

during the life of the settlor and his spouse. Likewise, if such trust was

exclusively to benefit Israeli descendants, it would also be a Relative’s

Trust. Note, however that once the Settlor and his spouse are both

deceased, the trust would cease to be a Relative’s Trust and would

become an Israeli Resident Trust (as explained below). Also, if during the

Settlor’s life, the son who is an Israeli Beneficiary was named as a trustee

or exerted control over the trust, the son would be considered a Settlor and

cause make the trust to be an Israeli Resident Trust at that time.

Additionally, if the US daughter was named as a trustee or exerted control

over the trust, the daughter would be considered a Settlor. In such case,

the trust would only qualify as a Relative’s Trust if the ITA approved to treat

the daughter who is a Distant Relative to her brother and his descendants,

who are Beneficiaries, as a Relative’s Trust.

There are two options for the taxation of a Relative’s Trust—the

Distribution Track or the Current Income Track.

Distribution Track

The “Distribution Track” is the default option for the taxation of a Relative’s

Trust and does not require any filing or affirmative election by the

trustee.[xv] Under the Distribution Track, only distributions to Israeli

Beneficiaries are taxed, and they are taxed at a 30% tax rate. The 30% tax

rate applies only to the distribution of trust income and not of principal;

however, any distribution is considered to have been made first from the

4882-5745-5694, v. 1

income and then from principal. While the ITA allows a Relative’s Trust to

claim foreign tax credits, certain timing issues may arise within the

Distribution Track that do not always allow for the credit to be used. Note

that decanting a trust from one trust to another trust should not be

considered a distribution for these purposes.[xvi]

Although the trustee under the Distribution Track does not have to file with

the ITA, the Israeli Beneficiary must file an annual tax return if he receives

a distribution or if the Israeli Beneficiary does not receive any distribution

but (a) such Beneficiary is an Israeli resident at least 25 years of age, (b)

such Beneficiary is aware of his/her status as a Beneficiary, and (c) the

value of the trust assets at the end of the tax year is at least 500,000 NIS.

Current Income Track

The other option for the taxation of a Relative’s Trust is the “Current

Income Track.” Under the Current Income Track, non-Israeli sourced

income is allocated among all trust Beneficiaries and the portion of the

income attributed to the Israeli Beneficiaries in the tax year in which the

income accrued, is taxed at a 25% tax rate, regardless of whether the

income is distributed. If a trust is a completely discretionary trust with both

Israeli and non-Israeli Beneficiaries and all or some of the income is

retained in the trust and not in a given year, the portion of the retained

income attributable to the Israeli Beneficiaries would be likely based on the

percentage of the Beneficiaries who are Israeli.[xvii] Thus, for example if

there were 10 permissible Beneficiaries of a trust—5 US residents and 5

Israeli residents, 50% of the income would be taxed in Israel at a 25%

rate. This would likely be the case, even if in past years all distributions

went to the US Beneficiaries. Under Current Income Track, the trust will

generally receive a foreign tax credit for US taxes paid by the trust.

Although the Current Income Track offers a lower tax rate on distributions,

one disadvantage of this track is when a grantor trust is funded by sale or

loan as that transaction, which is ignored for US income tax purposes,

would be recognized for Israeli income tax purposes and subject to the

25% tax rate. This would also be the case if a grantor exercised his

reserved right in a grantor trust to substitute assets of equivalent value with

the trust.

4882-5745-5694, v. 1

In order to elect the Current Income Track, the trustee of a Relative’s Trust

must notify the ITA of the trust’s status as a Relative’s Trust and make the

Current Income Track election within 60 days from the creation of trust or

from the day it becomes a Relative’s Trust. Failure to file within the 60

days will preclude the trust from electing the Current Income Track unless

special approval is granted by the ITA.

Additionally, any Israeli Beneficiary is required to file annual tax returns if

the Beneficiary receives a distribution from the trust or if Beneficiary does

not receive a distribution but (a) such Beneficiary is an Israeli resident at

least 25 years of age, (b) such Beneficiary is aware of his/her status as a

Beneficiary, and (c) the value of the trust assets at the end of the tax year

is at least 500,000 NIS.

Israeli Resident Beneficiary Trust

An Israeli Resident Beneficiary Trust is a trust where at least one

Beneficiary is an Israeli and the trust has never had an Israeli Settlor and

there is no family relationship between the Beneficiaries and the Settlor.

Although this type of trust is technically different than an Israeli Resident

Trust (described below), the reporting requirements and the taxation of

these trusts are the same as the Israeli Resident Trust and are described

below.

Israeli Resident Trust

Israeli Resident Trust is a trust where at the time of its creation, at least one

Settlor and one Beneficiary are Israeli residents, and in the current tax year

at least one Settlor and one Beneficiary are Israeli residents[xviii]. In

addition, any trust that does not qualify as one of the other trusts outlined in

this article will default to being classified as Israeli Resident Trust. In other

words, this is the default regime for a trust that does not meet the

definitions of the other trust types. The most prevalent example of an Israeli

Resident Trust is when the Settlor and Settlor’s spouse die in a Relative’s

Trust. At such time, a Relative’s Trust will generally become an Israeli

Resident Trust.

In general, an Israeli Resident Trust is taxed on its worldwide income in the

same way as an Israeli resident individual is taxed. As a result, all the

income of an Israel Resident Trust will become subject to tax in Israel on a

4882-5745-5694, v. 1

current basis, including income which is designated to be distributed to

non-Israeli Beneficiaries and including income of a grantor trust. The

trustee will be responsible for reporting and paying tax on this income and

for notifying the ITA of any distribution made in the tax year, including the

names of the Beneficiaries and the amounts distributed to them.

Furthermore, the Israeli Beneficiaries will be subject to reporting on any

distributions as described above.

Because an Israeli Resident Trust is regarded to be Israeli tax resident, this

impacts the trust’s ability to receive tax credits for US taxes. For example,

capital gains taxes paid in the US would not be recognized as a foreign tax

credit to be used against Israeli capital gains tax. For dividend or interest

income from US sources, taxes paid in the US would be credited by Israeli

but only at 25% for dividends and 17.5% for interest. Any additional taxes

on dividends might not be recognized as a foreign tax credit against Israeli

taxes on dividends. Additionally, a classification as an Israeli Resident

Trust could affect other deductions and depreciation.

If an Israeli Resident Trust is also deemed to be a resident of the US for US

purposes, there is a risk of double taxation of the trust income, and

unfortunately the tax treaty between Israel and the US does not solve a

situation of double residency of a trust. Hence, the only recourse with

respect to potential double tax on the trust’s income, can be a mutual

agreement procedure between the countries initiated by the taxpayer or

either tax authority to prevent double taxation.

Structuring Trusts to Minimize Israeli Taxation

One key to planning when your client wishes to create trusts for the benefit

of Israeli residents is to make sure during the client’s life that the trust

qualifies as a Relative’s Trust. For trusts with Israeli Beneficiaries, during

the lives of the Settlor and his spouse, so long as an Israeli Beneficiary of

the trust exerts control, they will be deemed a Settlor and the trust will not

qualify as a Relative’s Trust. Additionally, if a non-Israeli Beneficiary exerts

control, he will be deemed a Settlor and may be a Distant Relative rather

than closely related to some of the Beneficiaries, which could also

jeopardize the trust’s status as a Relative’s Trust. Thus, if the trust is

classified as Relative’s Trust and it has both Israeli resident beneficiaries

and non-Israeli beneficiaries, care should be taken to make sure that none

4882-5745-5694, v. 1

of the Beneficiaries are trustees or otherwise in a position to exert control of

the trust.

Another key to planning is to separate trusts as much as possible so that

separate trusts are created for Israeli residents and for non-Israeli

residents. Trusts for non-Israeli residents should not be subject to tax or

reporting in Israel even if an Israeli resident is a trustee. Also, trusts

exclusively for Israeli resident Beneficiaries will be fully subject to Israeli

taxes by the Israeli Beneficiaries minimizing any disconnect between the

US and Israel to avoid double taxation.

Care should also be taken for clients who create revocable trusts for

themselves. Often, children are included as potential current beneficiaries

of these trusts but this should be avoided for clients who have children who

are Israeli residents. Instead should the client wish to make gifts to their

children, distributions should be made from the trust to the client and then

from the client to the children directly, avoiding the trust having any tax

reporting in Israel.

In conclusion, whenever engaging in trust planning with clients who wish to

benefit Israeli residents, extreme care should be taken to make sure the

trust plan does not unnecessarily trigger Israeli income taxes or reporting.

In these situations, the best practice is to consult with Israeli tax counsel to

ensure the trust is structured to minimize any Israeli income tax exposure.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE

DIFFERENCE!

Mary O’Reilly

Yair Benjamini

Shiran Polishuk

4882-5745-5694, v. 1

CITE AS:

LISI International Tax Planning Newsletter #39 (December 5, 2022)

Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any

Person Prohibited Without Express Written Permission. This newsletter is

designed to provide accurate and authoritative information in regard to the

subject matter covered. It is provided with the understanding that LISI is not

engaged in rendering legal, accounting, or other professional advice or

services. If such advice is required, the services of a competent

professional should be sought. Statements of fact or opinion are the

responsibility of the authors and do not represent an opinion on the part of

the officers or staff of LISI.

CITATIONS:

[i]

Section 75E of the Ordinance.

[ii]

Note that an unborn person can be considered a Beneficiary and the

Israeli Tax Authority (“ITA”, which is Israel’s equivalent of the IRS) can

argue that the residency of the unborn person is the same as his/her

parent’s residency. Thus, if a trust is for the benefit of grandchildren only

and all grandchildren are living in the US but one child is living in Israel,

because that child could have a child in the future, the ITA can argue the

trust has an Israeli beneficiary.

[iii]

Section 75D of the Ordinance

[iv]

Section 75D(a)(4) of the Ordinance.

[v]

In Income Tax Circular 5/2016 (“Circular 5/2016”), which is titled “Trust

Taxation”, the ITA also addressed this issue and presented examples of a

Beneficiary's influence which might lead to classify him as a Settlor of the

trust:

 The beneficiary has powers in relation to the determination of the

beneficiaries, the trustee or the management of the trust assets.

 
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      The beneficiary is a member of the trust's investment committee or its 
other governing body. 
      The beneficiary has provided to the trust and/or companies held by the 
trust, directly or indirectly, services such as management or consulting 
services. 
      The beneficiary has a managerial position in one of the companies or 
ventures held by the trust. 
      The trust assets constitute security for a loan taken out by the 
beneficiary in a trust not in accordance with the trust deed. 
      A loan granted to a beneficiary for a period of X years that is not on 
market terms and is not in accordance with trust deed.  
[vi]
 Governed by Section 75I of the Ordinance. 
[vii]
 Governed by Section 75J of the Ordinance. 
[viii]
 Governed by Section 75H1 of the Ordinance. 
[ix]
 NEED CITE FOR THIS FN 
[x]
 Governed by Section 75H1 and Section 75G of the Ordinance. 
[xi]
 Note an Israeli non-profit is not considered a beneficiary for this purpose.  
[xii]
 This assumes no tax liability was due.  
[xiii]
 The Spouse must have been married to the Settlor when the Settlor 
made at least one contribution to the trust. 
[xiv]
 It is not clear under the current authority if this assessment by the ITA’s 
needs to be done at the outset, upon the establishment of the trust, upon 
its classification as a Relative’s Trust, at the time of a distribution to the 
Distant Relative or when the trust is required to file an annual.  
[xv]
 Technically, a trustee is required to notify the ITA within 60 days of the 
creation of a Relative’s Trust.  Although failing to make such notification 
may result in a penalty of up to 500 NIS per month, if no distributions have 
been made from the trust, it is likely this penalty will not be assessed. 

4882-5745-5694, v. 1

[xvi]

In addition, section 75D(b) of the Ordinance which is titled “Settlor of the

Trust” provides, “If a trustee contributed an asset or income to another

trustee, then the settlor who contributed the asset or income to the trustee

shall be deemed the person who contributed it to the other trustee, and the

trustee shall not be deemed a settlor.”

In Circular 5/2016, the ITA clarified the meaning of this section as follows:

“Section 75D (b) of the Ordinance provides that if a trustee contributes an

asset or income to another trustee (i.e.: to another trust, whether new or

existing), the settlor of the original trust shall be treated as a settlor of the

new trust as well, and the new trustee shall be stepped into the original

trustee's shoes. In this case, the original trustee will not be viewed as the

settlor of the new trust and the classification of the trust will not change due

to this action alone. It will be clarified that this section does not derogate

from section 75D(a)(3) of the Ordinance.”

Therefore, we can conclude that a transfer of an asset or of income from a

trustee of one trust to a trustee of another trust will not be considered as a

“distribution” under the Israeli law.

[xvii]

Although there is no clear guidance on the allocation of income among

the Beneficiaries, this is the common recommendation for tax reporting for

this scenario.

[xviii]

In the event where the last settlor of an Israeli Resident Trust has

passed away and the Trust has at least one Israeli beneficiary, then the

Trust will maintain its status as an Israeli Resident Trust.