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Trust Law/Level VI · Protection/6.2 Offshore/Lesson 1

International and offshore trusts

What makes a trust ‘international’ or ‘offshore’, the ordinary reasons such trusts exist, and why they do not change US tax for US settlors.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. For a US person the leanest route is usually a domestic trust, domestic under IRC §7701(a)(30)(E) when a US court supervises and US persons control substantial decisions, avoiding Form 3520-A and foreign trustee fees. Catch: one foreign person’s veto can make it foreign.
  2. A foreign trust saves no US income tax: IRC §679 treats a US transferor as owner while any US beneficiary may exist, so income is taxed to the settlor. Catch: file Form 3520 with your return and see that Form 3520-A is filed.
  3. Families spread across countries can lawfully use one trust under a single governing law for succession, recognized under the 1985 Hague Trusts Convention where ratified. Catch: each US recipient reports distributions on Form 3520, or faces the greater of $10,000 or 35%.
  4. Gifts and bequests from non-US persons carry no US gift tax for the recipient, but over $100,000 in a year they go on Form 3520 Part IV. Catch: gifts from related foreign persons must be added together when counting toward the threshold.

MaterialsThe IRS page ‘Abusive trust tax evasion schemes: special types of trusts’, which explains when a trust is foreign for US tax, free on irs.govLesson 1.2.7, on the Hague Trusts Convention, and lesson 5.1.5, on grantor trustsLesson 6.2.4, on the US reporting duties that apply to foreign trusts

Wonder

  1. Can a trust be ‘foreign’ for US tax even if its trustee lives in the United States?
  2. Why might a family spread across several countries use a trust governed by a third country’s law?
  3. Who pays US tax on the income of a foreign trust set up by a US person?

Explore

  1. There is no single legal definition of an ‘offshore’ trust. The term usually means a trust governed by the law of, and administered in, a jurisdiction other than the settlor’s home country, often a financial centre such as Jersey, the Cayman Islands or the Cook Islands. It is still an ordinary trust with a settlor, trustee and beneficiaries. Its validity and the trustee’s duties depend on the chosen governing law, and courts in many countries recognise such trusts, including under the Hague Trusts Convention of 1985 (lesson 1.2.7).
  2. US tax law uses its own test. Under IRC §7701(a)(30)(E), a trust is domestic only if a US court can exercise primary supervision over its administration and one or more US persons control all its substantial decisions. A trust that fails either test is foreign. So a trust governed by a US state’s law can be foreign for tax if, for example, a foreign person holds a power over a substantial decision, and a trust with a foreign trustee is not automatically ‘offshore’ for every purpose.
  3. Many international trusts serve ordinary purposes. Families with members, property and businesses in several countries may use one trust to hold assets under a single governing law and to plan succession across borders. Pension schemes, investment funds and the financing vehicles described in lesson 6.2.6 also use trusts in international financial centres. People who are not US persons may use them for reasons unconnected with US law. Such uses are lawful when the assets and income are reported as the law requires.
  4. For a US person, moving assets into a foreign trust usually does not change US income tax. Under IRC §679, a US person who transfers property to a foreign trust is treated as its owner for any year in which the trust has a US beneficiary, and a trust is presumed to have one unless its terms rule it out. The trust is then a grantor trust (IRC §§671–679, lesson 5.1.5), so its income is taxed to the settlor. The IRS describes such trusts as usually ‘U.S. tax neutral’.
  5. Foreign trusts with US connections carry their own reporting rules under IRC §6048. A US person reports transfers to, and distributions from, a foreign trust on Form 3520, and a foreign trust with a US owner must file Form 3520-A. Foreign accounts may also need FBAR and Form 8938 reports. Lesson 6.2.4 covers these forms, deadlines and penalties. The IRS warns that failing to report a transfer or distribution can bring a penalty of 35% of the gross amount (IRC §6677).
  6. Some offshore jurisdictions also have creditor-protection statutes, discussed in lessons 6.2.2 and 6.2.3, but those statutes bind local courts and do not stop a US court from acting against a settlor within its reach. Running a trust under two legal systems means advisers in each, a professional trustee and continuing tax filings. Costs vary widely by place, complexity and adviser. This lesson explains how international trusts are treated; it does not suggest using one.

Key facts

  • ‘Offshore trust’ is not a legal term of art; it usually means a trust governed by and administered under the law of a jurisdiction outside the settlor’s home country.
  • Under IRC §7701(a)(30)(E), a trust is domestic for US tax only if a US court has primary supervision and US persons control all substantial decisions.
  • International trusts have ordinary uses, such as succession planning for families with ties to several countries and holding investment and financing structures.
  • Under IRC §679, a US person who transfers property to a foreign trust with a US beneficiary is treated as its owner, so the trust’s income is taxed to that person.
  • Under IRC §6048, US persons report transfers to and distributions from foreign trusts on Form 3520, and foreign trusts with US owners file Form 3520-A.
  • Offshore creditor-protection statutes bind local courts only and do not stop a US court from acting against a settlor within its reach.

Exercise nine, six, three, one

9CollectList up to 9 features of an international trust described in this lesson or a reliable source you are reading (some sources give fewer), such as its governing law, where the trustee is, where the beneficiaries live and which forms are filed.
6ClusterSort them into 6 categories: governing law, trustee and administration, beneficiaries, purpose, US tax treatment, and reporting duties.
3DistillReduce the 6 categories to 3 groups: features that make the trust foreign for US tax, features that decide who is taxed, and features that create reporting duties.
1CrystallizeWrite 1 sentence explaining, in your own words, why a foreign trust set up by a US person usually does not change that person’s US income tax.

Fact check

Dates, figures and claims checked against the published sources listed below.

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