What Is a Foreign Trust and How Does It Affect U.S. Tax Reporting?

Over the past few decades, the IRS has made an effort to increase awareness of reporting regulations for foreign trusts.  If you are a U.S. taxpayer with financial ties to a foreign country, you may have a foreign trust that requires U.S. tax reporting.

Here are answers to some common questions we receive regarding U.S. taxation and reporting requirements for foreign trusts:

What is a foreign trust?

Generally, a trust is a structure in which legal title to property is transferred from the owner ("grantor") to another party ("trustee"), who will then administer the property for the benefit of a third party ("beneficiary"). Under US law, a trust that was organized in a foreign country and subject to that country’s laws and courts is a foreign trust.

How is a foreign trust taxed by the US?

For U.S. tax purposes, trusts are taxed as grantor or non-grantor trusts. When the grantor retains an incidence of ownership over the assets transferred to a trust, it is treated as a grantor trust under IRC Sec. 671- 679, and its income and capital gains are taxed to the grantor as if the assets had never been transferred.  When the grantor gives up all incidence of ownership over assets transferred to a trust, the trust is taxed as a non-grantor trust in a manner similar to individuals. A foreign trust may be taxed as a grantor or non-grantor trust.

Why would a U.S. person own or be a beneficiary or a foreign trust?

We live in an increasingly mobile global society, consequently, many U.S. taxpayers have moved to the U.S. from, or have family members, in foreign countries and own or are the beneficiaries of trusts created in other countries. Trusts arrangements are common worldwide because they offer benefits such as preservation of property for future generations, asset protection, or a vehicle to carry on scientific, philanthropic, religious, or humanitarian purposes.  

What U.S. tax reporting is required for a foreign trust?

If a foreign trust has a U.S. owner or beneficiary, U.S. tax reporting will be required. Transfers to, distributions from and annual income and expenses of foreign trusts must be reported on Forms 3520 and 3520-A as appropriate.  These are filed annually, and reporting is based on US accounting principles.

How do I know if I have a foreign trust to report on my taxes?

Sometimes it is obvious that an arrangement is a trust and should be reported as such. However, there are several types of foreign income tax deferred financial vehicles that may be considered trusts for US reporting.  For example, tax deferred investment vehicles such as Canadian RESP’s and TFSA’s are often treated as trusts, although there is disagreement among practitioners as to whether these arrangements should be reported as trusts and no clear guidance from the IRS.

What do I do now?