What is a Foreign Trust?

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Explaining a Foreign Trust in Easy-to-Understand Language

In this global economy, it’s becoming increasingly common for U.S. citizens and residents to have financial ties overseas. These financial ties often come in the form of foreign bank accounts, real estate holdings, and trusts.

Foreign trusts in particular are subject to special rules under the Internal Revenue Code (“IRC”).  However, understanding what constitutes a foreign trust and its treatment under the IRC can be difficult even for the most seasoned lawyer.

What is a Trust?

The Internal Revenue Service (“IRS”) defines a trust as “an arrangement created either by a will or by an inter vivos declaration [in other words, a declaration during the life of the person setting up a trust] whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.”[1]

In the United States, trusts are formed under state law. Thus, the law of the particular state in which the trust has been or will be formed must be consulted for any particulars regarding trust formation and administration. However, below are some general definitions that may prove helpful in the discussion that follows:

“Beneficiary”: The “beneficiary” is the person for whose benefit the trustee holds the property in the trust.[4]

Is a Trust Domestic or Foreign?

The IRC defines a foreign trust as any trust that is not domestic.[5] A trust is domestic if it meets the Court Test and the Control Test:

As can be seen, the determination of whether a trust is domestic or foreign is nuanced and usually decided on a case-by-case basis based on the trust instrument and applicable law.[13]

Grantor versus Non-Grantor Foreign Trusts

Once a trust is determined to be foreign, it is also important to figure out whether it’s a grantor or non-grantor trust under the IRC.

What are the IRS Requirements for Reporting Foreign Trusts?

The IRS imposes various reporting requirements for foreign trusts. U.S. persons who create a foreign trust, or have involvement with a foreign trust such as certain beneficiaries, are required to report foreign trust information on a IRS form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.[21] Foreign trusts treated as owned by U.S. persons under the grantor trust rules set out above also must file a Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner. Failure to comply with the reporting requirements for foreign trusts can result in significant penalties.[22]

Need Answers to Foreign Trust Questions?

Freeman Law is a world-renowned law firm specializing in complex tax planning and litigation. The firm represents clients of all sizes, from Fortune 100 fastest-growing companies to family-owned businesses, to individuals with estate planning questions. Freeman Law can help answer all your foreign trust questions in a language you can understand. Leave the detailed foreign trust research to the legal and tax professionals at Freeman Law.

[1] Treas. Reg. § 301.7701-4(a).

[2] Restatement (Third) of Trusts § 3(1), Comment a. (2003).

[3] Restatement (Third) of Trusts § 3(3), Comment c. (2003).

[4] Restatement (Third) of Trusts § 3(4), Comment d. (2003).

[5] I.R.C. § 7701(a)(31)(B).

[6] Id. § 7701(a)(30)(E)(i); Treas. Reg. § 301.7701-7(a)(1)(i).

[7] Treas. Reg. § 301.7701-7(c)(3)(iv).

[8] Id. § 301.7701-7(c).

[9] Id. § 301.7701-7(c)(4)(ii).

[10] I.R.C. § 7701(a)(30)(E)(ii); Treas. Reg. § 301.7701-7(a)(1)(ii).

[11] I.R.C. § 7701(a)(30); Treas. Reg. § 301.7701-7(d)(1)(i).

[12] Treas. Reg. § 301.7701-7(d)(1)(ii).

[13] Treas. Reg. § 301.7701-7(b).

[14] I.R.C. §§ 672-679.

[15] Id. § 671.

[16] Id. § 671(a).

[17] Id. § 641(b).

[18] Treas. Reg. § 1.1-1(b).

[19] See I.R.C. §§ 871, 881, 882.

[20] Id. § 684.

[21] See id. § 6048; Notice 97-34.

[22] See id. § 6677.