Foreign trusts can create serious tax and reporting obligations for US citizens and residents. While these structures may be set up for legitimate estate planning or asset protection reasons, they are treated with deep suspicion by the IRS. Understanding the tax treatment and compliance obligations is crucial to avoid significant penalties.
What Is a Foreign Trust?
A foreign trust is any trust that does not meet both of the following conditions:
Court Test: A US court can exercise primary supervision over the administration of the trust.
Control Test: One or more US persons have authority to control all substantial decisions of the trust.
If a trust fails either test, it is considered foreign for US tax purposes.
Who Is Affected?
US citizens or residents who are grantors (creators) of a foreign trust. US beneficiaries who receive distributions from a foreign trust. US persons who serve as trustees of a foreign trust.
Key US Tax Forms and Reporting Obligations
Form 3520: Must be filed by US persons who: Create a foreign trust. Transfer assets to a foreign trust. Receive distributions from a foreign trust.
Form 3520-A: The foreign trust itself (or the US owner on its behalf) must file this annual information return. It discloses the trust’s income, assets, and distributions.
Form 8938: May be required if the foreign trust assets or distributions exceed FATCA thresholds.
FBAR (FinCEN 114): If the trust account(s) are considered financial accounts over which the US person has signature authority or beneficial interest, FBAR filing may be triggered.
Failure to file these forms can lead to severe penalties, often starting at $10,000 per form, per year.
Taxation of Foreign Grantor Trusts
If a US person is treated as the grantor of a foreign trust (typically where they retain certain powers or interests), they are taxed on the trust’s income as if it were their own, even if no distributions are made.
All income, gains, and losses flow through to the grantor’s US tax return. Form 3520-A is required to report these details.
Taxation of Foreign Non-Grantor Trusts
US beneficiaries of non-grantor foreign trusts are taxed only when distributions are received.
Current year distributions of income are taxed at ordinary income rates. Accumulated income (from prior years) triggers the throwback rule, which applies punitive tax rates and an interest charge to compensate for tax deferral. Distributions may include a mix of current income, accumulated income, and return of capital. This must be tracked properly.
Example Scenario
Emma, a US citizen living in London, is the beneficiary of a foreign trust set up by her UK parents. In 2024, she receives a $50,000 distribution.
She must file Form 3520 to report the receipt. If the trust has not filed Form 3520-A, Emma may be on the hook for penalties unless she attaches a substitute 3520-A to her own return. The distribution may include both current and accumulated income, subject to the throwback rule.
UK Considerations
The UK also taxes trust distributions, and trust income may be attributed to settlors or beneficiaries depending on local rules. Double taxation is a risk, and foreign tax credits may help, but coordination is complex. The US-UK tax treaty does not directly eliminate US reporting obligations for foreign trusts.
Final Thoughts
Foreign trusts can be tax and compliance minefields for US persons. The IRS expects a high level of transparency, and noncompliance can be extremely costly.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
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