If you’re learning about foreign trusts for US tax purposes, one of the first distinctions to understand is between foreign grantor trusts and foreign non-grantor trusts. These two types of trusts are treated very differently under US tax law, even if they look similar on paper. This guide explains the key differences in simple terms.
What Makes a Trust a Grantor or Non-Grantor Trust?
Foreign Grantor Trusts
A foreign grantor trust can be established by a US grantor or a non-US grantor, but the rules are different in each case:
US Grantor
- The trust becomes a grantor trust if the US grantor keeps powers over the trust, such as deciding how income is used or distributed.
- Even if the grantor does not directly hold these powers, they may be treated as having them if a non-adverse party (someone who is not a beneficiary) holds them instead.
- If the trust is foreign and could eventually benefit US persons, it may automatically be a grantor trust to prevent attempts to avoid US taxation.
- Once classified as a grantor trust, all income of the trust is considered to belong to the US grantor for tax purposes.
Non-US Grantor
- A foreign trust with a non-US grantor only becomes a grantor trust if:
- The grantor can revoke the trust (alone or with consent of a related non-adverse party); or
- All income or principal is paid only to the grantor or their spouse during the grantor’s lifetime.
- Income of such trusts generally belongs to the non-US grantor and is taxed in the US only if it is US-source income.
Foreign grantor trusts can be useful for planning because distributions to US beneficiaries may occur without immediate US taxation, as long as reporting rules are followed.
Foreign Non-Grantor Trusts
Any trust that is not a grantor trust is a non-grantor trust. A foreign non-grantor trust is usually taxed similarly to a non-US individual:
- The trust itself is generally only subject to US tax on US-source income.
- Distributions to US beneficiaries are subject to special rules:
- Beneficiaries are taxed on the trust’s distributable net income (DNI) for the year.
- If the trust distributes more than the DNI, the excess is treated as undistributed net income (UNI), which may carry an interest charge under the “throwback” rules.
- Use of trust property by a US beneficiary or loans from the trust are generally treated as taxable distributions.
- Ownership of foreign corporations through the trust may trigger additional tax rules for US beneficiaries, even if no distribution is made.
Key Differences at a Glance
| Feature | Foreign Grantor Trust | Foreign Non-Grantor Trust |
|---|---|---|
| Income attributed to | Grantor (US or non-US) | Trust itself until distributed |
| US beneficiaries taxed | Only when they receive distributions | Taxed on DNI or accumulation distributions |
| Use of property | Can often be distributed with limited immediate US tax | Use treated as distribution with potential tax |
| Planning considerations | Can allow flexible distributions to US beneficiaries | Subject to stricter taxation rules and reporting obligations |
Final Thoughts
Understanding whether a foreign trust is a grantor or non-grantor trust is essential for US persons involved with these trusts. It determines who is taxed on trust income and how distributions are treated under US tax law.
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.
