Foreign grantor trusts: tax strategies for cross-border families and wealth management
Foreign trusts are a popular tool for families managing wealth across borders. A foreign grantor trust is a type of trust established outside the US, generally by a non-US person who retains certain powers or ownership rights.
While these trusts can be highly efficient for estate planning and global asset protection, they come with strict tax reporting rules, especially when there are US beneficiaries or owners involved. If you're a US citizen or resident who owns, benefits from, or contributes to a foreign grantor trust, you're likely subject to complex IRS filing requirements.
This guide covers everything you need to know about foreign grantor trust taxation, from basic definitions to advanced planning strategies.
This article is brought to you by Taxes for Expats (TFX) – a top-rated tax firm serving US citizens, residents, and anyone with US tax obligations, both at home and abroad. Are you a grantor or beneficiary of a foreign grantor trust? Have questions about tax requirements? We’re here to assist you – learn more about our tax services or contact us.
Who can benefit from a foreign grantor trust (FGT)?
A foreign grantor trust (FGT) can be a valuable tool for cross-border families, international estate planning, and high-net-worth individuals (HNWIs). Let’s explore who might benefit most and how.
US persons with foreign family members
US persons with foreign family often find foreign grantor trusts particularly valuable for cross-border estate planning. For example, a US citizen who has married into an Australian family may become a beneficiary of a family trust there.
During the grantor’s lifetime, the trust allows the US beneficiary to receive distributions without immediate US tax consequences while the foreign grantor maintains control over the assets.
Non-US persons planning for US heirs
Non-US persons planning for US heirs represent another key group that benefits from foreign grantor trust structures.
Example: A non-US person establishes a revocable trust in Switzerland and can transfer assets to benefit his US children while avoiding US gift taxes during his lifetime. The trust assets grow without US tax consequences, and distributions to the US children are treated as tax-free gifts rather than taxable income.
High-net-worth individuals seeking asset protection or tax deferral
High-net-worth individuals often utilize foreign grantor trusts as part of wealth management strategies. This structure provides asset protection benefits while deferring US tax on foreign-source income and capital gains during the grantor’s lifetime.
Key tax features and planning opportunities
Foreign grantor trusts (FGTs) offer distinctive planning advantages, especially while the grantor is alive. Their primary benefit lies in how income is taxed.
Income attribution to the grantor
Under US tax rules, the grantor is treated as the owner of the trust’s assets. All trust income is attributed to them – even if not distributed.
If the grantor is a non-US person, only US-source income (like US dividends) is taxable in the US.
Tax deferral and beneficiary benefits
Since the grantor is taxed on trust income, US beneficiaries can often receive distributions tax-free during the grantor’s lifetime. These distributions are typically considered gifts, not taxable income. Meanwhile, the trust can accumulate untaxed foreign earnings and capital gains – creating potential tax deferral and liquidity benefits for international families.
Estate planning flexibility
FGTs allow non-US settlors to provide for US family members while keeping control. The grantor can often revoke the trust, change beneficiaries, or adjust distribution terms – offering both asset control and tax efficiency.
What happens when the grantor dies?
Upon the grantor’s death, the trust becomes a foreign non-grantor trust, and the rules change:
- Distributions to US beneficiaries may trigger tax under the throwback rules, which apply ordinary income tax and interest charges on previously accumulated income.
- New Form 3520 filings may be required.
- Step-up in basis may apply to trust assets only if the assets are included in the grantor’s gross estate for estate tax purposes under IRC sections 2036–2042. Assets excluded from the gross estate generally do not receive a step-up in basis per Revenue Ruling 2023-2.
Additionally, assets once exempt from PFIC rules may become subject to them, increasing future tax exposure. Because of these shifts, post-death planning is essential to preserve the trust’s long-term tax efficiency and avoid surprises for US heirs.
Structuring the foreign grantor trust: best practices
Designing a foreign grantor trust (FGT) requires close attention to tax classification, holding structure, and long-term planning – especially if US beneficiaries are involved.
Grantor vs. non-grantor trust structure
A foreign grantor trust attributes all income to the grantor, regardless of distributions. This can be beneficial when the grantor is a non-US person, as foreign-source income is generally not taxable in the US.
In contrast, a foreign non-grantor trust doesn’t tax income as it accrues but imposes US tax (including throwback rules) on distributions to US beneficiaries.
| Foreign grantor trust (FGT) | Foreign non-grantor trust | |
|---|---|---|
| Income taxed to | Grantor (if US or foreign person) | US beneficiaries (upon distribution) |
| Complexity | High; allows planning opportunities | Higher; subject to throwback rules |
| Best used for | Estate planning, tax deferral, asset control | Multigenerational wealth transfer |
Holding companies: estate and income tax planning
Direct ownership of US-situs assets by a foreign trust can expose them to US estate tax at the grantor’s death, with only a $60,000 exemption. To mitigate this, FGTs often hold these assets through non-US corporations treated as disregarded entities, preserving grantor status and protecting against estate tax.
However, post-2017 tax law changes eliminated the safe harbor for liquidating these holding companies within 30 days of the grantor’s death. Now, such liquidations may trigger CFC-related income and capital gains recognition for US beneficiaries, requiring more advanced post-death structuring.
Investment considerations: PFIC risk and planning
FGTs must carefully navigate passive foreign investment company (PFIC) exposure. While the trust’s non-US grantor is treated as the income owner during life, protecting US beneficiaries from PFIC tax, this protection disappears after death.
To reduce PFIC exposure, use US-compliant ETFs or mutual funds, work with managed portfolios that avoid PFICs, and consider private placement life insurance wrappers.
Best practices for structural flexibility:
- Draft revocation powers carefully to preserve grantor status while maximizing estate planning flexibility.
- Build in provisions for a step-up in basis at the grantor’s death.
- Consider tiered holding company structures to stagger post-death liquidations and ease tax consequences.
- Churn appreciated assets during the grantor’s life to avoid built-up gains subject to future tax.
By combining thoughtful structuring with forward-looking planning, an FGT can balance tax efficiency with compliance and long-term family wealth goals.
Reporting requirements and IRS compliance
Even if no US-taxable income is earned, foreign trust reporting requirements are strict, and penalties can be substantial.
Required forms:
- Form 3520: Filed by US grantors, beneficiaries, or transferors to report ownership, transfers, or distributions.
- Form 3520-A: Filed annually by the trust (or the grantor, if the trustee fails to file). It reports the trust’s income, expenses, and distributions and includes a Beneficiary Statement for each US recipient.
| Role | Form 3520 | Form 3520-A |
|---|---|---|
| US grantor | Yes | Yes (if trustee fails) |
| US beneficiary | Yes (if distribution received) | No |
| Non-US trustee | No | Yes (if trust has US owner) |
| Non-US grantor | No | No (for US tax) |
The US owner must file a substitute 3520-A if the trustee fails to do so.
Penalties:
- Failure to file Form 3520-A: Greater of $10,000 or 5% of the gross value of US-owned trust assets.
- Failure to file Form 3520: Up to 35% of distributions or property transferred
Penalties can escalate if not corrected within 90 days.
US heirs may need to file Form 8621 annually for any PFIC investments owned through the trust. US persons may also need to file Form 5471 (for foreign corporations held by the trust) adding further complexity.
Exceptiond for certain retirement plans: IRS provides specific exceptions for Canadian RRSPs and RRIFs from Form 3520 and 3520-A reporting due to Revenue Procedure 2014-55.
While the IRS has offered limited relief for late filings, taxpayers must show reasonable cause. Given the high stakes, working with a tax professional is strongly recommended.
Need help navigating foreign trust rules?
Are you an owner, beneficiary, or contributor to a foreign trust? Confused about IRS reporting requirements or which forms you need to file? At Taxes for Expats, we help US taxpayers around the world stay compliant with foreign trust reporting. Book your free discovery call – we’ll review your situation and guide you through your next steps.
