What US tax issues are there for US taxpayers with foreign trusts?

How does a trust become a US problem?

A foreign trust may need to make US filings if it has either US beneficiaries or a US owner, where the owner of the trust is the person who settles the property into the trust. For these purposes a US person includes a US citizen, green card holder or any individual who meets the “substantial presence test” during the tax year.

For US purposes there are two types of foreign trusts: grantor and non-grantor. The grantor is the individual who settled assets into the trust. A trust is normally a grantor trust where the grantor retains some control or a benefit in the assets within the trust, and they are seen from a US perspective as being the owner of the trust assets. Income from a foreign grantor trust is generally taxable on the grantor, regardless of who the beneficiaries are. Income from a non-grantor trust is normally subject to US tax when distributed to US beneficiaries, unless there is US sourced income within the trust, in which case the trustees would pay the US tax.

Action: Please let us know if you are involved with a trust and you think there may be a US owner or beneficiary. You may need to determine the US tax status and actions required. It can be quite common for a non-US trust to have a US reporting obligation, but sometimes the trustees can be unaware of the US status of the owner/beneficiaries meaning the US tax status of a trust is undetermined. 

Reporting requirements 

In certain circumstance, there are yearly reporting forms which must be filed by the trustees of a foreign grantor or foreign non-grantor trust. Failure to file these reports can lead to substantial penalties, with penalties assessable on the US owner. If there is not a US owner of the trust, penalties will be assessable on the trustees.

Action:  For non-compliant trusts there are various disclosure routes that trustees can follow to bring a trust up to date with its US obligations. If you are unsure about which disclosure route applies to your trusts, please get in contact. We can prepare the filings needed in both of these situations.

Taxation for owners and beneficiaries

A US owner of a foreign grantor trust is subject to US Income Tax on the portion of trust income that they are considered to own. The trustees must report this income on a statement provided to the Internal Revenue Service (IRS).

A US beneficiary of a foreign non-grantor trust should receive a statement from the foreign trust determining the taxability of any distribution; however the trustees do not need to provide this to the IRS. If this statement is not provided to beneficiaries the default position can lead to the entire distribution being taxable as accumulated income on the beneficiary’s US tax return. Calculations need to be undertaken to determine how much of the distribution will be comprised of current year income, prior year income and trust corpus (capital). There are complicated “throwback tax rules” which assess an interest charge on distributions from prior year accumulated income.

Action: Significant savings can be achieved if a distribution is split into taxable and non-taxable elements, rather than being taxed as 100% taxable income. We are experienced with preparing these calculations (UNI/DNI calculations).

How we can help

Buzzacott's 50-strong Expatriate Tax Services team of dual-qualified US and UK tax advisors can guide you in making decisions that work in both the short- and long-term, while avoiding pitfalls and unexpected consequences. We can provide assistance with determining if a foreign or non-US trust has any US compliance obligations. From there we can help to calculate the taxability of any future distributions from the trust and prepare the necessary annual reporting forms.

For further guidance and advice tailored to your situation, please reach out to your usual Buzzacott contact. Alternatively, please complete the form below and a member of our team will be in touch.