A Foreign Non-Grantor Trust Distribution Taxation Overview

A Foreign Non-Grantor Trust Distribution Taxation Overview

Foreign Non-Grantor Trust Distribution Taxation

In general, the key difference between a grantor trust and a non-grantor trust for US tax purposes boils down to who is going to be taxed on the income – the grantor or the beneficiaries? With a grantor trust, wherein the grantor is still considered the owner of the trust, the grantor is responsible to pay the income tax. The main reason why is because the IRS does not want wealthy grantors assigning income to lower-income tax bracket beneficiaries who may pay US taxes at a lower progressive tax rate — and then have the beneficiaries gift that money back to the grantor so that there is a significant tax gap. Conversely, with a non-grantor trust, since the grantor is no longer the owner of the trust, the Grantor is not taxed on the income but rather the beneficiaries who receive the income distributions are taxed. Foreign trust tax law and Form 3520/3520-A reporting is a very complicated aspect of international tax law, so let’s go through some of the basics.

Foreign Non-Grantor Trust Beneficiary Pays the Tax

When a beneficiary receives a distribution from a foreign non-grantor trust the Beneficiary is subject to US tax on that income. In other words, with the non-grantor trust, it is the beneficiaries who are subject to the tax and not the grantor (since the grantor is no longer the owner of the assets) The beneficiary will report the income directly on their US tax return and for the most part, the income retains the character it had.

Income Keeps the Same Character (Mainly)

While most of the time the income generated and distributed retains the same character it had, this does not apply with respect to the throwback rule and previous DNI income that was not reported and thus became UNI. And, while, with foreign trusts capital gains are considered DNI (different tax treatment than US non-grantor trust counterpart) – if that income is not distributed then it becomes UNI, and it loses its character and becomes taxed at ordinary income.


DNI refers to Distributable Net Income and UNI refers to Undistributed Net Income. With complex foreign trusts (with simple trusts this is not really an issue because all income must be distributed each year), income that was not distributed and is retained by the Trust but distributed later may not only lose its character in certain situations but there is also interest tacked on and as a result, the amount of taxes paid can be significantly more than the original character of the income.

Non-Grantor Trust Beneficiary Statement

US beneficiaries who receive foreign non-grantor trust distributions are supposed to receive non-grantor trust beneficiary statements. If the taxpayer who is a beneficiary in the United States does not receive this form from the trustee, it can negatively impact the tax preparation and reporting requirements, depending on which specific calculation the taxpayer uses to report their income.

Reporting on Form 3520

In addition to the taxation of foreign non-grantor trust distributions, there is the pesky requirement of having to disclose the information to the US government on Form 3520. Taxpayers may also have to complete a Form 3520-A – if they are deemed an owner at all of the foreign non-grantor trust. The failure to properly report trust distributions from a foreign Grantor or Non-Grantor Trust on for Form 3520 may result in significant fines and penalties.

Missed Prior Tax and Reporting

If a person failed to report in prior years, they are not out of luck. The US government has developed various international information tax amnesty programs, collectively referred to as offshore voluntary disclosure. Some of the more common programs include Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures –– but there are other options available as well.

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Golding & Golding: Our International Tax Lawyer team specializes exclusively in international tax, and specifically IRS offshore disclosure.

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