For US taxpayers, foreign trusts can raise questions about taxes and reporting obligations. One common type is the foreign grantor trust, which has unique rules under US tax law. This guide explains the basics in simple terms.

What Is a Foreign Grantor Trust?

A foreign grantor trust is a trust which does not meet both the US court and control test and meets the grantor trust criteria. The criteria for grantor and non-grantor trust classfication can be found in our previous guide, but here is a summary;

Foreign grantor trusts can be established by either US grantors or non-US grantors, but the tax treatment differs depending on who the grantor is.

US Grantor

If a US person funds a foreign trust and retains one or more grantor trust powers, the trust is treated as a grantor trust for US tax purposes. Examples of grantor trust powers include:

• Deciding how the trust income is used.
• Distributing income or principal for the benefit of the grantor or their spouse.
• Holding powers indirectly through a non-adverse party, such as a trustee or protector who is not a beneficiary.

Even if a US grantor does not initially retain these powers, the trust can automatically become a grantor trust if it could eventually benefit US persons. This rule prevents using foreign trusts to shield income from US taxes.

Non-US Grantor

A trust with a non-US grantor is generally treated as a grantor trust only if:

1. The grantor can revoke the trust (alone or with a related non-adverse party), or
2. All income or principal is payable only to the grantor or their spouse during the grantor’s lifetime.

Otherwise, the non-US grantor is generally not taxed on the trust’s income unless it is US-source income.

How Foreign Grantor Trusts Are Taxed

For US grantors, the key point is that all income of the trust is attributed to the grantor. This means:

• The grantor reports and pays US taxes on the trust’s income, even if no distributions are made.
• Distributions to US beneficiaries from a foreign grantor trust are generally not taxed again, provided reporting obligations are met.

For non-US grantors, US tax applies only to US-source income, and distributions to US beneficiaries may be made without immediate US tax.

Reporting Requirements

US grantors and beneficiaries of foreign grantor trusts have specific reporting duties:

• Form 3520: US beneficiaries who receive distributions or other benefits must report them using this form.
• Form 3520-A: Trustees of a foreign grantor trust must file this annual information return. The form provides details about trust income, distributions, and US owners.
• Beneficiaries should receive a Foreign Grantor Trust Owner or Beneficiary Statement from the trustees to help complete their own filings.

Failing to file these forms correctly or on time can result in significant penalties. Appointing a US agent can help ensure proper reporting and reduce the risk of the IRS determining taxable income on its own.

Key Takeaways

• A foreign grantor trust attributes all income to the grantor for US tax purposes.
• US grantors must report the trust income and may make distributions to US beneficiaries without additional tax.
• Non-US grantors are only taxed on US-source income.
• Proper reporting with Forms 3520 and 3520-A is essential to avoid penalties.

Final Thoughts

Understanding these rules is crucial for US taxpayers involved with foreign grantor trusts. Properly identifying the trust type and fulfilling reporting obligations ensures compliance with US tax law while taking advantage of available planning opportunities.

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.