The term “foreign trust” might sound complicated, but it’s a key concept for anyone involved with trusts that have connections to the United States. This guide will break down the basics.
What Is a Trust?
Before understanding a foreign trust, it’s important to know what a trust is. A trust is a legal arrangement where often one person (the settlor) puts assets (money, property) into the care of another person or entity (the trustee) to manage for the benefit of a third party (the beneficiary), separating legal ownership from beneficial interest to protect and pass on wealth, often for specific purposes like inheritance or tax planning. It’s possible for one person to be more than one key party.
Key Parties
- Settlor (or Grantor): The person who creates the trust and puts assets into it.
- Trustee: The person or company who legally holds and manages the assets according to the trust’s rules.
- Beneficiary: The individual or group who benefits from the trust’s assets
When Is a Trust “Foreign”?
Once you know an entity is a trust, the next step is figuring out whether it counts as a foreign trust for US tax purposes. A trust is foreign if it fails either the Court Test or the Control Test.
The Court Test
The Court Test looks at whether a US court has primary authority to supervise the trust’s administration. Administration means carrying out the trustee’s duties according to the trust document and applicable law.
A trust satisfies the Court Test if a US court can fully oversee its administration. Typical situations include:
- The trust is registered with a US court.
- A testamentary trust has trustees qualified by a US court.
- An intervivos trust has taken steps to place its administration under US court supervision.
- Both a US and foreign court share primary supervision.
However, a US court does not have authority if the trust document includes a clause that automatically moves the trust out of the US if a court tries to intervene. Trusts without such clauses, administered exclusively in the US, typically meet the Court Test.
The Control Test
The Control Test asks whether one or more US persons have full power over all substantial decisions of the trust. “Substantial decisions” include major choices outlined in the trust document, like distributing property or income.
If any non-US person, such as a foreign trustee or protector, can veto a substantial decision, the trust may fail the Control Test and be considered foreign, even if it is otherwise administered in the US.
Why the Tests Matter
Both tests work together:
- A trust is domestic for US tax purposes only if it passes both the Court and Control Tests.
- If it fails either test, it is considered a foreign trust, even if it seems domestic at first glance.
This distinction is important because a trust’s classification affects reporting obligations and how the trust’s income and distributions are treated under US law.
Key Takeaways
- A trust is an arrangement where trustees hold property for beneficiaries.
- A foreign trust is any trust that fails the Court or Control Test for US tax purposes.
- The Court Test checks if a US court can supervise the trust.
- The Control Test checks if US persons have authority over major trust decisions.
- Even trusts administered in the US can be foreign if a foreign person has veto power over decisions.
Final Thoughts
Understanding whether a trust is foreign is the first step for US persons involved in cross-border estate planning. Knowing the classification helps ensure compliance with US reporting rules and sets the stage for understanding how foreign trusts are taxed.
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.
