Updated Guidance on Israel Trust Income Tax Laws

August 16, 2016Alerts Taxation and Wealth Planning Alerts

Effective January 1, 2014, Israel imposed an income tax on trusts established by foreign (e.g., U.S.) grantors that have at least one beneficiary who is an Israeli resident. New guidance was issued on Aug. 16, 2016, in a circular by the Israel Tax Authority.

We first discussed the details of this change in Israel's tax laws in a November 2013 alert.

The new circular:

  • Repeats the recent amendment to the 2014 law that requires Israeli beneficiaries from the age of 25 to file tax returns if their "share" of the trust is NIS 500,000 or higher, even in years where no distributions were made (distributions are reportable to all).
    This provision raises an important question: Since exchange rates change, asset values fluctuate and the reporting requirement is annual, does this mean that some beneficiaries may not need to report every year?
  • Confirms that taxes paid to a foreign (e.g., U.S.) tax authority due to trust income that is taxable in Israel, including state taxes but excluding city taxes, may be used as a foreign tax credit (reducing Israeli taxes).
    This credit will be allowed for taxes paid by the trust, the grantor (on trust income) and the beneficiary (on income distributions). The availability of the foreign tax credit has been a significant issue of discussion until now.
  • Underscores a problematic situation: When a foreign grantor whose trust has one or more Israeli beneficiaries passes away, the entire trust becomes an Israeli Resident Trust and all of its income is taxable and reportable in Israel. This applies to testamentary trusts as well. However, we understand that the ITA is writing new bylaws to exempt the "share" of the foreign beneficiaries in these trusts.
    In practice, some Israeli accountants have already been reporting these trusts using only the income allocated to the Israeli beneficiaries, and the ITA is aware of this and has made no attempt to change this reporting since they apparently agree with the principle. One issue to note in these trusts is that the United States may not enjoy the "first bite" of income tax, at least not that attributed to Israeli beneficiaries, which may be a challenge to U.S. tax preparers.

If you have questions about any of the issues discussed in this alert, please contact Debra T. Hirsch at [email protected] or 973.994.7813.