For a U.S. person living abroad, owning or being a beneficiary of a foreign trust creates complex reporting obligations with the internal revenue service. These rules are designed to prevent tax avoidance and ensure that foreign financial assets are properly disclosed.
This article explains what a foreign trust is, how the grantor trust rules apply, the differences between grantor trusts and non grantor trusts, how they are taxed, and the strict reporting requirements for Form 3520 and Form 3520-A.
Key Takeaways
- A foreign trust is any trust that fails the court test or control test for primary supervision.
- A grantor trust is taxed directly to the U.S. owner, while a foreign non grantor trust is taxed separately, with distributions taxed to the U.S. beneficiary.
- Form 3520 is always required when a U.S. person owns or receives distributions from a foreign trust, while Form 3520-A applies only to a foreign grantor trust.
- The penalty for late filing form 3520-A is automatic and rarely abated.
- Foreign trusts may offer asset protection purposes, but they carry strict reporting requirements under U.S. tax law.
What is a foreign trust?
A foreign trust is any trust that fails either the court test or the control test:
- Court Test: A U.S. court must be able to exercise primary supervision and assert jurisdiction over the administration of the trust.
- Control Test: One or more U.S. persons must control all substantial decisions of the trust.
If either test is not satisfied, the trust is classified as foreign. For example, a pension plan in a foreign country like the Cook Islands, administered exclusively abroad, is a foreign trust. In contrast, a domestic trust meets both tests and remains under U.S. authority.
This distinction is increasingly common as expats discover they hold foreign financial assets that are automatically treated as part of a foreign trust under applicable law.
What is the difference between a grantor trust and a non grantor trust?
The difference between a grantor trust and a non grantor trust comes down to control and tax treatment under the internal revenue code.
- Grantor Trust
A grantor trust exists when the U.S. owner (the grantor) retains powers such as the ability to revoke the trust, amend the trust instrument, direct investment decisions, change beneficiaries, or borrow from the trust. For income tax purposes, the trust is disregarded as a separate entity. This means all income generated and capital gains are reported on the grantor’s own tax return, and the grantor pays U.S. income tax on the trust earnings.- Example of a foreign grantor trust: A U.S. citizen sets up a revocable trust in Canada or holds a foreign bank account through a foreign trust but keeps the right to manage or withdraw funds. This is treated as a foreign grantor trust, and the U.S. person must report income on their personal return and comply with Form 3520 and Form 3520-A filing.
- Non Grantor Trust
A non grantor trust arises when the grantor gives up control after the property transferred to the trust. The trust is treated as a separate taxable entity with its own employer identification number. It pays U.S. tax only on U.S.-source income and income effectively connected with a U.S. trade or business. Distributions of distributable net income are taxed to the beneficiary, while distributions of principal (the original property held) are not taxable. Non grantor trusts are often used for asset protection purposes and estate planning since the assets are removed from the grantor’s estate.- Example of a foreign non grantor trust: A U.S. person establishes a trust in Switzerland where an independent trustee makes all substantial decisions. The grantor no longer has signature authority or access. This becomes a foreign non grantor trust, and a U.S. beneficiary who receives distributions must file Form 3520 to report them.
How are foreign trusts taxed?
The way a foreign trust is taxed depends on whether it is a grantor trust or a foreign non grantor trust.
Foreign Grantor Trust
- Taxation: The U.S. owner is taxed on all income and capital gains of the entire trust. For income tax purposes, the trust is ignored, and earnings are reported directly on the owner’s return.
- Filing obligations:
- Form 3520-A: Filed each taxable year by the trustee, or by the U.S. owner if the trustee does not. Reports the fair market value, property transferred, and the administration of the trust.
- Form 3520: Filed with the owner’s personal return to report transactions and ownership.
- Example: A U.S. citizen holding a foreign bank account through a revocable trust in Canada. Even without distributions, the owner must report all income as personal taxable income.
Foreign Non Grantor Trust
- Taxation: The trust is its own taxpayer. It pays U.S. tax only on U.S.-source income. A beneficiary pays tax when they receive distributions of distributable net income. Distributions of principal or property held are not taxable.
- Filing obligations:
- Form 3520-A: Not required, since there is no U.S. owner.
- Form 3520: Must be filed by a U.S. beneficiary to report distributions or foreign gifts above IRS thresholds.
- Example: A trust in Switzerland managed by an independent trustee. A U.S. beneficiary who receives a distribution must file Form 3520 even though the trust is administered exclusively outside the United States.
What are the filing obligations of U.S. expats with a foreign trust?
Here are the key filing obligations:
1. Form 3520 – Annual Return to Report Transactions With a Foreign Trust
- Must be filed by any U.S. person who:
- Creates or transfers assets to a foreign trust.
- Is treated as the U.S. owner of a foreign trust.
- Receives distributions, certain foreign gifts, or inheritance from a foreign trust.
- Discloses property transferred, distributions received, and other report transactions with the trust.
- Due with the expat’s U.S. income tax return.
If you want to learn more about Form 3520, check out our detailed guide here.
2. Form 3520-A – Annual Information Return of Foreign Trust With a U.S. Owner
- Must be filed annually by the trustee, or by the U.S. owner if the trustee will not.
- Provides a full accounting of the foreign trust, including assets, legal title, and how substantial decisions are made.
- Reports the fair market value of the trust’s assets each taxable year.
- Failure to file results in an automatic penalty.
If you want to learn more about Form 3520-A, check out our comprehensive guide here.
3. FBAR (FinCEN Form 114) – Foreign Bank Account Reporting
- Must be filed if the foreign trust holds accounts at a foreign bank or other institutions and the aggregate balance exceeds $10,000.
- Applies if the U.S. person has a financial interest or signature authority over the account, even if the trust holds legal title.
For a detailed explanation of FBAR rules and how to file, check out our FBAR compliance guide.
4. Form 8938 – Statement of Specified Foreign Financial Assets
- Required if a U.S. person meets reporting thresholds for specified foreign financial assets, which include interests in foreign trusts.
- Thresholds are higher for expats living outside the United States, but the obligation still applies when exceeded.
For a full breakdown of reporting thresholds and requirements, see our Form 8938 guide.
5. U.S. Income Tax Return (Form 1040)
- Any income from a foreign trust that is taxable to the U.S. owner or distributed to a U.S. beneficiary must be reported on the expat’s U.S. tax return.
- For a grantor trust, the U.S. owner reports all income as if earned directly.
- For a foreign non grantor trust, the beneficiary reports taxable distributions in Part I of Form 1040.
Other Considerations
- Foreign persons (nonresident aliens) who create or fund trusts for the benefit of a U.S. person can trigger these rules.
- Transfers from a domestic corporation or domestic partnership into a foreign trust may also create reporting requirements.
What are the penalties and due dates for Forms 3520 and 3520-A?
- Form 3520
- Due date: Same as the U.S. person’s income tax return (April 15, June 15 for expats, with extensions).
- Penalty: Greater of $10,000 or 35% of the fair market value of property transferred or distributions received.
- Form 3520-A
- Due date: March 15 (or September 15 with a filing extension).
- Penalty: The greater of $10,000 or 5% of the total value of trust assets owned by the U.S. person.
Automatic Penalty Warning: The penalty for late filing of Form 3520-A is automatic. While technically possible to request abatement for reasonable cause, in practice the IRS almost never grants relief. Once the deadline is missed, the automatic penalties apply, and in our experience they cannot be avoided.
