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A Guide to Foreign Trusts

What exactly is a foreign trust? And how do they affect tax reporting? Trust & Will explains what you need to know about foreign trusts.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Welcome to the realm of foreign Trusts! If you’ve manifested this guide to fall into your lap, perhaps it’s because you’ve been curious about financial ties you have, or plan to have, overseas. In this internationalized economy, it’s increasingly common for Americans to have Trusts in other countries. The reverse scenario is also true: American expats living in foreign countries who have estate plans back home in the U.S.. Today we’ll perform a deep dive on everything you need to know about the foreign trust, including what makes a trust foreign, your tax implications, and any other important pieces of information that would serve you.

What is a Foreign Trust? 

A foreign Trust is a Trust that was established in a foreign country and is subject to that country’s estate planning laws. In other words, U.S. courts would not have any legal jurisdiction over that Trust. It’s easiest to think about the foreign trust definition in terms of how the Trust is governed. If it’s governed by laws outside of the U.S., then it’s a foreign Trust.

As a reminder, a Trust is a legal entity into which the grantor transfers the legal title of property. They also name another party, the trustee, who will have the legal right to administer the property owned by the Trust. Some duties include managing the property held by the Trust, plus overseeing the distribution of assets to named beneficiaries per the grantor’s wishes. 

The rest of this guide will expand on the ins and outs of a foreign Trust in particular; if you’d like to brush up your knowledge on Trusts, we recommend visiting our “What is a Trust” guide. 

What is the Main Benefit of a Foreign Trust?

The main benefit of using a foreign trust is the opportunity to protect your assets based upon the laws established by the jurisdiction in which your Trust was organized.

To be clear, all Trusts are designed to better protect your assets to a certain degree. Depending on the way your Trust is organized, you can avoid U.S. probate court, lower some of your tax liabilities, and maintain your privacy. (Our Types of Trusts guide expands on a few different ways to organize your trust.) 

However, the protections offered by U.S. Trust laws do not necessarily translate to protections offered by laws enforced in other countries. For instance, the level of privacy and protection from creditors offered by a foreign Trust established in Japan may be completely different from what is offered in the U.S.

According to GDB Law, some popular destinations for foreign Trusts include the Cayman Islands, the Cook Islands, Bermuda, and the Isle of Man. These jurisdictions are commonly used for foreign Trusts by grantors because of their low or non-existent taxes and lack of restrictions on currency exchanges. Another important factor to consider is the stability of government, which provides grantors the peace of mind that policies are not as likely to change. 

Another reason an individual might establish a foreign Trust is to increase the protection of their assets. For example, it is possible for future claims to be made against your assets. Although Trusts organized in the U.S. offer limited protection against creditors and other types of claims, the level of protection is increased significantly when a Trust is held overseas. This is because the cost of litigation instantly increases when it goes outside U.S. borders. When costs become prohibitive, creditors are more likely to lessen the claim and settle. 

Assets held in a foreign Trust aren’t just insulated from commercial creditor claims, they can also protect against divorce claims, forced inheritance claims, and civil actions. However, note that most countries honor the reciprocal enforcement of criminal cases and convictions.

How Are Foreign Trusts Taxed?

Know that moving your assets into a foreign Trust will not exempt you from certain taxes. The Internal Revenue Service will enforce the taxation of foreign Trusts as either a grantor or non-grantor Trust. 

A grantor Trust describes a Trust for which the grantor retains some ownership over the assets. In this case, any income and capital gains made by property held in a foreign Trust are taxed as if the property had never been transferred into the foreign Trust in the first place.

A non-grantor Trust is established when the grantor gives up all ownership of the assets or property that are transferred into the Trust. In this case, the foreign Trust is taxed as an individual entity. 

What U.S. Tax Reporting is Required for a Foreign Trust?

If a beneficiary based in the U.S. were to receive any distributions from a foreign trust, they would be required to report this distribution to the Internal Revenue Service (IRS). More specifically, they would use Form 3520, even if the distribution weren’t normally taxable income.

In addition, foreign trusts and trustees based in the U.S. may have a Foreign Bank and Financial Accounts (FBAR) reporting obligation. According to the U.S. Financial Crimes Enforcement Network (FinCen), a “A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.” The specific reporting form FinCen Form 114.

You should also be prepared to file IRS Forms 3520 and 3520-A. Form 3520 is a filing that is required of any individual who receives foreign gifts or distributions from foreign trusts. Form 3520-A is an informational form used to report on any U.S. owner or U.S. beneficiary of a foreign trust.

Last but not least, use IRS Form 8938, which is the “Statement of Specified Foreign Financial Assets.” This form requires you to report foreign financial assets specified by the IRS, if the total value of those assets exceed the reporting threshold set by the IRS.

How Do You Set Up a Foreign Trust?

First and foremost, know that organizing a foreign trust could cost up to several thousand dollars. Before you decide to set up a foreign trust, you should have clarity on the reason for doing so. Perhaps you own several non-U.S. assets, and it makes logistical sense to create a trust in the country in which those assets are owned. Or, perhaps you have a significant amount of funds that warrant stronger protection. These are possible reasons for which an individual would go through the cost and effort required to set up a foreign Trust.

If you should choose to move forward, here is a general overview of how to set up a foreign Trust:

  1. Review and appoint a professional trustee who is established outside of the United States.

  2. Review and appoint a protector who is also established outside of the United States.

  3. Draft and solidify your foreign Trust document.

  4. Open or consolidate your foreign bank and brokerage accounts.

  5. Make gifts to the Trust (as you the grantor.)

  6. File required Internal Revenue Service (IRS) forms including but not limited to:

  • FBAR

  • Form 3520

  • Form 3520-A

  • Form 8938

Note that the process of organizing a foreign Trust can change, based on the estate planning laws of the country that will govern your Trust. It would behoove you to consult a financial professional and legal professional who have experience in advising clients who own foreign Trusts.

Create Your Trust Today

Establishing a foreign trust can be a great tool for those who desire added protection. A foreign trust can help insulate your assets from creditors and other claims. Perhaps you have a large amount of assets that warrant a foreign trust, or perhaps it simply makes logistical sense for you to organize a trust abroad. 

Regardless, it’s very important to understand that you still have some tax implications and reporting requirements in the U.S. This is also true for Americans who may not necessarily own a foreign Trust, but may be receiving gifts and distributions from a foreign Trust. 

Keep in mind that, at the end of the day, one of the best ways to protect your assets (and to keep your life simple) is to establish a Trust at home. We mean this both literally and figuratively. By working with Trust & Will, you can easily establish your Trust right here in the U.S. from the comfort of your own couch. U.S. Trusts also provide a myriad of tax benefits and protections for your assets. The tricky part is knowing which type of Trust to use, but don’t worry, our experts can help you with that.

In this guide we talked about what makes a Trust foreign, why an individual might want to use a foreign Trust, and the tax implications and reporting requirements they might face. A foreign Trust is any Trust that was organized outside the U.S. and falls into the jurisdiction of a non-U.S. country. Americans who own foreign Trusts should understand their tax liabilities and reporting requirements in both the U.S. and the foreign country in which the Trust was organized.

We also discussed that any U.S.-based individuals might have reporting and tax responsibilities, even if they don’t own a foreign Trust themselves. This is true if they serve as the trustee or as a beneficiary of a foreign Trust. 

Foreign Trusts can be quite complicated, so it’s always best to consult a professional.

Is there a question here we didn’t answer? Reach out to us today or Chat with a live member support representative!