Your Family Set Up a Trust Abroad. What Does the IRS Require of You?

What makes a trust foreign

A trust is domestic only if a U.S. court can exercise primary supervision over its administration and one or more U.S. persons have authority to control all substantial decisions. Failing either test makes the trust foreign. Because control of substantial decisions is often held by relatives, protectors, or professional trustees outside the United States, arrangements that feel local to the family are foreign for these purposes.

The label used abroad does not control

A foundation, an anstalt, a stiftung, a usufruct arrangement, or a nominee holding structure may be treated as a trust for U.S. purposes even though local law calls it something else. The analysis looks at how the arrangement functions, not at its name.

The two principal forms

Form 3520

Filed by the U.S. person. It covers the creation of a foreign trust and transfers to it, ownership of a foreign trust under the grantor trust rules, and distributions received from a foreign trust — including indirect benefits such as the rent-free use of trust property or a loan from the trust. It is filed separately from the income tax return, which is a frequent source of missed filings.

Form 3520-A

This is the annual information return of the trust itself, required when a U.S. person is treated as the owner of any portion of a foreign trust under the grantor trust rules. Practically, the U.S. owner is responsible for ensuring it is filed, and its due date is earlier than the individual return deadline. A foreign trustee who has never heard of the IRS will not file it on their own, so the U.S. person usually has to arrange it and may need to file a substitute.

What counts as a distribution

• Cash paid to a beneficiary or paid on a beneficiary's behalf
• Use of trust-owned property, such as living in a trust-owned home, without paying market rent
• Loans of cash or marketable securities from the trust, unless they meet the requirements to be treated as qualified obligations
• Payment of a beneficiary's expenses, tuition, or debts directly by the trust

Families are often surprised by the second and third items. A beneficiary who has never received a payment may still have a reportable distribution because of how they use trust property.

Why the tax result can be severe

Distributions from a foreign nongrantor trust that carry out accumulated income can be subject to the throwback rules, which recharacterize part of the distribution and impose an interest charge on the deferral. If the trust does not provide the statements needed to compute the amounts properly, a default calculation method may apply, and it is rarely favorable to the beneficiary. Obtaining trust accounting records is therefore not a formality — it directly changes the tax.

Penalty exposure and correction

Penalties for failing to file Forms 3520 and 3520-A are computed by reference to the value of the transfer, distribution, or trust assets rather than to any tax owed. Reasonable cause relief exists, and the IRS has changed how it administers certain of these penalties over time, but relief is fact-dependent and never automatic. If prior years were missed, the correction path should be chosen before anything is filed.

Practical steps for U.S. beneficiaries

Ask for the trust deed and any amendments, identify who holds power over substantial decisions, obtain annual trust accounts, and document every benefit received during the year, including non-cash benefits. If you are named in a structure a relative created without telling you, the obligation still attaches to you. Getting the documents while the family members who set it up are available is far easier than reconstructing the history later.

Sources and official references

• IRS — About Form 3520
• IRS — About Form 3520-A
• IRS — Foreign Trust Reporting Requirements