Taxation of foreign Trusts
Service note: We prepare U.S. tax returns and coordinate complex international items such as foreign trust reporting (Forms 3520/3520-A, related schedules). Learn more here: U.S. Tax Return Service.
What is a “foreign trust”. For U.S. tax purposes, a trust is “foreign” if it fails either the court test (primary supervision by a U.S. court) or the control test (one or more U.S. persons have authority to control all substantial trust decisions). A trust that is not domestic under these tests is treated as foreign. Classification can be sensitive to governing law, trustee/protector powers, and practical administration.
Grantor vs. nongrantor. U.S. rules divide trusts into grantor trusts (income is taxed to the person treated as the “owner”) and nongrantor trusts (the trust is a separate taxpayer; beneficiaries are taxed when they receive income/distributions as determined by distributable net income, “DNI”). Special rules for foreign trusts—especially §679—can treat a U.S. person who transfers property to a foreign trust with a U.S. beneficiary as the owner of that trust for U.S. purposes.
Foreign grantor trusts (FGTs). If a U.S. person is the grantor/owner (e.g., under §679 or the general grantor rules), the trust’s income is generally reported currently by that U.S. owner. If a non-U.S. grantor retains certain powers (e.g., a revocation power) and the trust benefits only the grantor or the grantor’s spouse, the trust may be treated as owned by the foreign grantor; U.S. beneficiaries then are typically taxed only on actual (or deemed) distributions they receive.
Foreign nongrantor trusts (FNGTs). A foreign trust that is not a grantor trust is a separate taxpayer for U.S. purposes. U.S. beneficiaries are taxable when they receive distributions of current-year DNI; distributions of accumulated income (UNDNI/UNI) from prior years can trigger a throwback and interest charge regime designed to neutralize deferral. Capital gains are often retained in corpus for U.S. purposes unless carried out under specific rules.
Distributions, loans, and use of property. Cash or property paid to a U.S. beneficiary is generally a distribution. In addition, certain loans of cash or marketable securities and certain uncompensated use of trust property by a U.S. person can be treated as deemed distributions unless strict “qualified obligation” or fair-market-value rules are met.
Transfers and recognition. U.S. persons who transfer appreciated property to a foreign nongrantor trust may face gain recognition under anti-deferral rules. Transfers to a foreign grantor trust may be excepted but are still reportable. Large foreign gifts or bequests to U.S. persons, and transfers to or from foreign trusts, often trigger separate information filings even when no immediate income tax arises.
Reporting and compliance. U.S. owners and U.S. beneficiaries have extensive information reporting obligations. Form 3520 reports certain transactions with foreign trusts (distributions received, transfers, gifts from foreign persons, ownership statements), while Form 3520-A is the annual information return for a foreign trust with a U.S. owner. If the trustee will not file 3520-A, the U.S. owner typically attaches a substitute to the Form 3520 filing. Substantial penalties can apply for late, incomplete, or missing filings.
Investments inside foreign trusts. Interests held by a foreign trust—such as PFICs, CFCs, partnerships, or insurance bonds—can carry their own U.S. regimes and forms (e.g., Form 8621 for PFICs). The ultimate U.S. tax result depends on whether the trust is grantor or nongrantor, whether income is distributed, and how U.S. anti-deferral rules interact.
Practical approach. Determine the trust’s residency (domestic vs. foreign) and tax character (grantor vs. nongrantor); identify U.S. owners and beneficiaries; map distributions (cash, in-kind, loans, property use); gather trustee statements (DNI/UNI/PTEP-like layers); and align reporting (3520/3520-A and any related forms). Careful modeling helps avoid unexpected throwback charges, duplication, or penalties.
Taxation of Foreign Trusts – Key Questions
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A trust is foreign if it fails either the court test (primary supervision by a U.S. court) or the control test (U.S. person(s) control all substantial decisions). If not domestic under those tests, it is treated as foreign.
Grantor trusts are taxed to the owner (grantor) on a current basis; nongrantor trusts are separate taxpayers and beneficiaries are taxed when they receive income carried out under DNI rules.
When a U.S. person transfers property to a foreign trust that has (or could have) a U.S. beneficiary, the U.S. person is generally treated as the owner for U.S. tax purposes, with ongoing income inclusion and reporting.
Commonly where the foreign grantor retains a power to revoke or where distributions are limited to the grantor or the grantor’s spouse; in those cases, U.S. beneficiaries are typically taxed only on actual or deemed distributions they receive.
The U.S. owner reports the trust’s income annually as if earned directly, regardless of distribution. Separate information returns are usually required to support the inclusion.
Current DNI carried out is taxable to the beneficiary. Distributions of accumulated income (UNI) can trigger a throwback calculation and interest charge designed to neutralize deferral.
Cash or property paid or credited to a U.S. beneficiary is generally a distribution. Certain indirect benefits (payments on behalf of, debt forgiveness) can also be treated as distributions.
Loans of cash/marketable securities or rent-free use of trust property by a U.S. person can be deemed distributions unless strict “qualified obligation” terms or fair-value arrangements are met.
DNI (distributable net income) caps the amount taxed to beneficiaries in the current year. UNI (undistributed net income) from prior years can cause throwback and interest charges when later distributed.
Capital gains are often allocated to corpus and not included in DNI unless carried out under specific rules or local law/trust accounting that treats them as income. Facts and governing instrument matter.
Form 3520 reports U.S. owner statements, distributions received, and certain transfers/gifts. Form 3520-A is the annual information return for a foreign trust with a U.S. owner and includes beneficiary/owner statements.
The U.S. owner generally attaches a substitute 3520-A to their timely Form 3520 to avoid or mitigate penalties. Coordination with the trustee is still strongly recommended.
Transfers to a foreign nongrantor trust can trigger gain recognition; transfers to a foreign grantor trust may be excepted. All such transfers are generally reportable even when non-taxable.
Yes. U.S. persons receiving large gifts/bequests from foreign individuals or estates may have Form 3520 reporting, even when the gift itself is not taxable income.
PFICs can require Form 8621 and special inclusions; CFC interests can trigger Subpart F/GILTI. Whether the trust is grantor or nongrantor changes who reports and how income flows to U.S. beneficiaries.
Under the court and control tests: primary supervision by a U.S. court and U.S. control over all substantial decisions make a trust domestic; failing either test makes it foreign.
Forms 3520/3520-A carry substantial penalties for late, incomplete, or missing filings, separate from any income tax due. Penalties can escalate quickly per form, per year.
Often yes. Options depend on facts, timing, and correspondence received. Professional guidance is advisable before contacting the IRS or filing late/incomplete forms.
Trust statements showing income character (DNI/UNI), distribution details, loan terms/repayments, property-use agreements, and any beneficiary statements furnished by the trustee.
Our cross-border team coordinates Forms 3520/3520-A, models DNI/UNI and any throwback exposure, and aligns PFIC/CFC issues. See our U.S. Tax Return Service or contact us.
Need help with foreign trust taxation and reporting? We integrate trust analysis with your U.S. return. Explore our service or get in touch.
