Trusts in the U.S. —How Foreign Investors Can Benefit From Them

When it comes to cross‑border wealth structuring, trusts offer a powerful and flexible tool. But for investors outside the United States (non‑resident aliens, foreign nationals, or persons with assets abroad) who are considering U.S. trusts (or U.S. law‑based trust structures), the rules can be complex and the tax consequences significant. This blog will walk you through the key types of trusts under U.S. law, what foreign investors should know, and how careful structuring can create potential benefits (and avoid pitfalls).

What is a Trust?

A trust is a legal arrangement in which one person (the “grantor” or “settlor”) transfers assets to another person or entity (the “trustee”) to hold for the benefit of one or more persons (the “beneficiaries”) according to the terms of the trust document. A family member is often chosen as a trustee or beneficiary, especially in cases involving children or relatives with special needs. In U.S. law, trusts are creatures of state law (each U.S. state has its own trust statute), but for federal tax purposes, the Internal Revenue Service (IRS) applies rules to determine whether a trust is domestic or foreign, whether it’s a grantor trust or non‑grantor trust, and how income, gains, distributions, and estate issues are taxed.

There are many types of trusts, including revocable trusts (which can be amended or revoked by the grantor during their lifetime), irrevocable trusts, living trusts, testamentary trusts (created by a will and activated after death), life insurance trusts (used to hold life insurance proceeds for estate planning), and dynasty trusts, among others.

Types of Trusts

There are several types of trusts available in the United States, each tailored to address specific financial goals and personal circumstances. The two primary categories are revocable trusts and irrevocable trusts. Revocable trusts, often called revocable living trusts, allow the grantor to maintain control over the trust assets during their lifetime, with the flexibility to modify or dissolve the trust as their needs change. This makes revocable trusts a popular choice for those seeking to avoid probate and maintain control over their estate plan.

Irrevocable trusts, by contrast, cannot be altered or revoked once established. These trusts are frequently used for asset protection and to minimize estate taxes, as the assets placed in an irrevocable trust are generally removed from the grantor’s taxable estate. For individuals seeking to support charitable causes, charitable trusts,  such as a charitable remainder trust, can provide both a stream of income to the grantor and a future benefit to a charitable organization. Other specialized trusts include grantor retained annuity trusts (GRATs), which are designed to minimize estate taxes by allowing the grantor to receive an annuity payment for a set period, with the remaining trust assets passing to beneficiaries at a reduced estate tax cost. Each trust type, whether it’s an annuity trust, charitable trust, or retained annuity trust GRAT, offers unique benefits for asset protection, tax planning, and maintaining control over the distribution of wealth.

Domestic vs. Foreign Trusts

One of the most important first distinctions for tax purposes is whether a trust is a U.S. domestic trust or a foreign trust. That classification affects how the trust is taxed and how beneficiaries are taxed.

According to IRS guidelines, a trust is treated as a U.S. (domestic) trust if:

• A U.S. court is able to exercise primary supervision over the administration of the trust (the “court test”).

• One or more U.S. persons have the authority to control all substantial decisions of the trust (the “control test”).

• If either test fails, the trust may be treated as a foreign trust.

Why does it matter? The classification determines what income is taxable, what reporting requirements apply, and how the U.S. estate and gift tax rules may apply.

Why Foreign Investors Might Use U.S. Trusts or Trusts Under U.S. Law

Foreign investors may look to U.S. trust structures for several reasons: asset protection, legal certainty, holding U.S. or foreign assets, estate‑planning flexibility, and tax structuring. Some of the potential benefits:

Holding Foreign Assets via a U.S. Trust for Foreign Beneficiaries

According to one analysis, non‑resident investors (foreign persons) may establish a U.S.-based trust, structured so that the trustee and key control tests make it a U.S. trust, which holds foreign business or investment assets for the benefit of non‑U.S. beneficiaries.

The benefit? Because the assets are foreign‑situs (i.e., located and invested outside the U.S.), the trust may be exempt from U.S. income tax on the foreign‐source income of those assets and may avoid U.S. estate tax on those non‑U.S. situs assets.

Asset Protection & Legal Certainty

U.S. trust law (especially in favorable states) may offer stronger protections and predictable outcomes compared to foreign jurisdictions whose laws might be less stable or uniform. For foreign investors seeking to invest globally, using a U.S. trust can provide legal certainty under U.S. law, enforceable trustee duties, and a familiar framework.

Estate and Succession Planning

For foreign individuals with multi‑jurisdictional assets or heirs, trust structures under U.S. law can help in succession planning: avoiding or reducing probate, enabling continuity of asset management, and potentially limiting estate tax exposure if properly structured. Comprehensive estate plans often involve trusts to efficiently transfer assets and manage cross-border wealth. Some jurisdictions’ local forced‑heirship rules (which require fixed shares to certain heirs) can be bypassed through trusts. Careful structuring and planning are essential; understanding your financial situation and consulting with financial advisors or a tax advisor is crucial for effective trust planning.

Tax Structuring Possibilities

Depending on how assets are held and how the trust is classified, foreign investors may leverage favorable tax treatment under U.S. law. For example, foreign trusts (if properly structured) may only be subject to U.S. tax on U.S. source income and effectively connected income, not worldwide income.

Key Tax Issues and Pitfalls for Foreign Investors

While there are opportunities, the tax landscape is full of risks if the structure is not carefully designed or administered. Some of the major issues to be aware of:

U.S. Income Tax Exposure

A domestic U.S. trust is taxed as a U.S. resident: it is subject to U.S. federal income tax on its worldwide income, including capital gains, even if the assets are held abroad.

A foreign trust is only subject to U.S. tax on its U.S. source income and income effectively connected to a U.S. trade or business. For example, intangible assets held outside the U.S. by a foreign trust might escape U.S. tax on capital gains.

U.S. Estate and Gift Tax Considerations

U.S. estate tax may apply to U.S. situs assets owned by non‑residents. For foreign investors, holding U.S. real estate or U.S. corporation stock directly can trigger estate tax exposure. One common estate planning strategy for married couples is to establish a credit shelter trust, which allows each spouse to maximize the use of their federal estate tax exemption. When one spouse passes away, assets up to the exemption limit are placed in the credit shelter trust for the benefit of the surviving spouse. The surviving spouse can receive income and, in some cases, access principal, but the trust assets are excluded from the surviving spouse's estate, minimizing overall estate taxes and ensuring a seamless transfer of assets to heirs.

Additionally, the generation-skipping tax exemption can be used to fund trusts that pass assets to grandchildren or other beneficiaries, allowing these assets to bypass estate taxes for multiple generations. Life insurance proceeds or trust assets can also be used to pay estate taxes, providing necessary liquidity for heirs and helping to avoid the forced sale of estate assets.

Transfers to or distributions from a foreign trust may trigger gift tax or be included in the grantor’s estate if they retain too much control.

Reporting Requirements

The IRS imposes heavy reporting obligations:

• Forms 3520 / 3520‑A for involvement with foreign trusts (U.S. persons transferring assets to foreign trusts or receiving distributions).

• FBAR (FinCEN Form 114) if you have signature authority or an interest in foreign financial accounts, including trust accounts.

Failure to comply can lead to severe penalties.

“Throwback Tax” and Distributions from Foreign Trusts

If U.S. beneficiaries receive distributions from a foreign non‑grantor trust that has accumulated income, they may be subject to the throwback tax regime: essentially, accumulated income gets taxed as if it had been distributed earlier (plus interest), and capital gains may be taxed as ordinary income.

Classification Risks

Misclassifying a trust (domestic vs foreign, grantor vs non‑grantor) leads to unintended tax exposure. For example, a foreign investor might create what they believe is a foreign trust—but if a U.S. person has too much control, the trust may be treated as a U.S. trust and taxed accordingly.

Strategies: How Foreign Investors Can Benefit If Structured Properly

Trusts can be used to transfer personal assets efficiently, allowing for the strategic movement of wealth. In certain trust structures, the remaining funds at the end of the trust term can be distributed to beneficiaries or charities, often with significant tax advantages. Additionally, using a charitable lead trust is a strategy that combines philanthropy with tax planning, providing income to charitable organizations while benefiting heirs.

Strategy 1: A U.S. Trust Holding Foreign Assets for Non‑U.S. Beneficiaries

Structure: A non‑resident (non‑U.S. person) sets up an irrevocable U.S. trust (so it meets the U.S. court/control tests and thus is a U.S. trust) whose trustee is a U.S. person or entity, the trust holds foreign assets (e.g., non‑U.S. business interests, foreign securities), and the beneficiaries are likewise non‑U.S. persons.

Potential benefits:

If structured correctly, the trust’s foreign‑situs assets may be exempt from U.S. estate tax (since the assets are not U.S. situs).

The income from foreign‑situs assets may not be subject to U.S. income tax if all income is from foreign sources and the trust is not engaged in a U.S. trade or business.

Use of U.S. trust law introduces legal certainty and asset‑protection features.

Key caveats:

Ensure no U.S. beneficiaries (or U.S. persons controlling the trust) that would re‑classify things or trigger unwanted U.S. tax obligations.

Ensure that no U.S. situs assets are owned (or minimize them) since those can trigger U.S. estate tax or U.S. tax on gains. For example, U.S. real estate is U.S.

Ongoing compliance is critical: Trustee, accounting, and distributions must follow rules.

Strategy 2: A Foreign Trust Holding U.S. Assets (for Foreign Beneficiaries)

Structure: A trust established offshore (foreign trust), assets include U.S. investments (or U.S. real estate via U.S. LLC), and beneficiaries are non‑U.S. persons.

Potential benefits:

A foreign trust is taxed by the U.S. only on U.S. source income and income connected to U.S. trade/business (and often not on gain from intangible assets or non‑U.S. assets) if structured correctly.

If the beneficiaries are non‑U.S. persons, distributions may avoid U.S. tax in certain cases.

Estate‑tax exposure can be reduced because for non‑U.S. trusts with non‑U.S. beneficiaries, U.S. tax may not apply to non‑U.S. situs assets.

Key caveats:

U.S. real property is U.S. situs and may trigger U.S. tax under the Foreign Investment in Real Property Tax Act (FIRPTA) when disposed of.

If a U.S. person is a grantor or beneficiary, or the trust retains too much connection to the U.S., you may trigger U.S. tax on the grantor or beneficiaries.

Foreign trustee jurisdictions and controls must be genuine; otherwise IRS may treat the trust as domestic or as a grantor trust.

Strategy 3: Holding U.S. Real Estate Via Trust and LLC for Foreign Investors

Structure: A foreign investor uses a U.S. trust (or U.S. entity) to hold U.S. real‑estate assets via a U.S. limited liability company (LLC). The trust holds the LLC. Beneficiaries are foreign persons.

Potential benefits:

If the trust is non‑grantor and structured carefully, the U.S. real‑estate asset may be isolated for estate tax purposes (for example, holding via LLC may treat shares as non‑U.S. situs if structured properly).

Rental income and gains may be managed via U.S. tax structuring (although note that real estate carries U.S. tax exposure, both income and dispositions).

Estate‑tax exposure for the foreign investor may be limited if the asset is held under a non‑U.S. entity treated as a corporation for U.S. tax purposes (so shares rather than direct real property).

Key caveats:

U.S. real estate remains a trigger for U.S. tax: FIRPTA withholding, U.S. estate tax, and U.S. income tax on rental income.

If the trust is treated as a U.S. trust (domestic), then worldwide income tax exposure kicks in.

Must manage state tax exposure (many U.S. states impose income or property taxes).

Important Tax Rules and What They Mean

Below are several tax rules that foreign investors using trusts must keep front‑of‑mind.

Trusts can be used to make financial gifts to beneficiaries while managing tax consequences. It is important to consult an investment adviser for professional investment management and to ensure prudent investment decisions are made within the trust. Please note that trust and investment services are not insured or guaranteed by any federal government agency.

Grantor Trust Rules (IRC §§ 671–679)

If the grantor retains certain powers or benefits, the trust may be treated as a “grantor trust,” meaning the grantor is treated as the owner of trust assets for U.S. tax purposes. This can result in immediate recognition of income and estate inclusion. Upon the grantor's death, the trust may become irrevocable, and the tax treatment of the trust's assets may change.

Distributable Net Income (DNI) & Throwback Rules

When a foreign non‑grantor trust distributes accumulated income to a U.S. beneficiary, this distribution carries out the trust’s “distributable net income” (DNI) and may trigger higher tax rates and interest for deferred years (“throwback tax”).

U.S. Estate Tax and Situs Rules

U.S. estate tax applies to U.S. citizens and residents on their worldwide assets; for non‑residents, U.S. estate tax generally only applies to U.S. situs assets (e.g., U.S. real property, tangible personal property in the U.S., stock of U.S. corporations in certain cases).
Trust structures matter: A properly structured trust may hold assets in a way that avoids U.S. estate tax for non‑U.S. persons if the assets are non‑U.S. situs and the trust is outside U.S. estate tax reach.

U.S. Income Tax on Foreign Trusts

A foreign trust is only taxed by the U.S. on U.S. source income and effectively connected income. Capital gains on intangible assets outside the U.S. may not be taxed.

Reporting Requirements

If you are a U.S. person who transfers to or receives distributions from a foreign trust, you must file Forms 3520 and 3520‑A. Also, FBAR/FinCEN 114 if you have signature authority or an interest in foreign financial accounts.

U.S. Tax for Foreign Investors Investing in U.S. Entities

While somewhat separate from trusts, a foreign person investing in U.S. entities (e.g., shares, funds) may be subject to U.S. withholding tax on U.S. source dividends (generally 30% unless reduced by treaty) and may not, in some cases, be subject to U.S. tax on capital gains (except U.S. real property).

Asset Protection and Trusts

Asset protection is a cornerstone of effective estate planning, and trusts are a powerful tool for safeguarding wealth against potential risks. Irrevocable trusts, in particular, offer robust asset protection because once assets are transferred into the trust, they are no longer considered part of the grantor’s personal estate. This means that, with proper planning, these assets are generally shielded from creditors, lawsuits, and other financial threats. However, asset protection trusts must be established proactively,  before any creditor issues arise, and without any intent to defraud or hinder creditors.

A well-crafted estate plan that incorporates asset protection trusts can help ensure that your wealth is preserved for your intended beneficiaries. In addition to protecting assets from creditors, certain trusts can also be structured to minimize estate taxes. For example, a grantor retained annuity trust (GRAT) allows the grantor to receive a fixed annuity payment for a specified term, with the remaining trust assets passing to heirs at a reduced estate tax cost. By integrating irrevocable trusts and annuity trusts into your estate planning, you can both protect assets and minimize estate taxes, providing long-term security for your family and future generations.

Trust Creation: Steps and Considerations

Establishing a trust involves several important steps and careful consideration of your financial and personal objectives. The process begins with determining the type of trust that best aligns with your goals—whether you seek asset protection, tax minimization, or charitable giving. Next, you’ll need to select a trustee, who will be responsible for managing the trust assets and ensuring your wishes are carried out. Funding the trust is a critical step, which involves transferring assets such as real estate, bank accounts, or investments into the trust’s name.

It’s essential to consider the tax implications of your trust structure. For example, certain trusts can help minimize estate taxes, while others, like a charitable remainder trust, may provide an immediate income tax deduction for the grantor and ongoing support for a charitable organization. Understanding the income tax consequences and estate tax implications of your trust is vital to achieving your estate planning objectives. Consulting with a financial advisor or attorney experienced in trust assets and tax planning can help ensure your trust is properly established, administered, and maintained in accordance with your wishes and applicable laws.

Trust Termination: When and How Trusts End

Trusts are designed to serve specific purposes, and there are several scenarios in which a trust may terminate. Common reasons for trust termination include the death of the grantor, the fulfillment of the trust’s objectives, or the expiration of a set term. In some cases, a court may order the termination of a trust if it is no longer necessary or if the trustee is unable to perform their duties. When a trust terminates, the remaining assets are distributed to the beneficiaries as outlined in the trust agreement.

It’s important to be aware that the termination of a trust can have significant tax implications. Beneficiaries who receive distributions of the remaining assets may be subject to income tax on those distributions, and there may also be estate tax considerations depending on the size and nature of the trust. Navigating the income tax consequences and estate tax issues that arise when a trust terminates can be complex, so it’s advisable to work with a tax professional to ensure compliance with all legal requirements and to optimize the outcome for all parties involved.

Benefits of Trusts for Foreign Investors

For foreign investors, trusts offer a range of strategic advantages in the United States, from asset protection to tax efficiency and estate planning. By establishing a trust, foreign investors can protect assets from creditors, lawsuits, and even potential government seizure, ensuring that their wealth is preserved for future generations. Trusts can also be structured to minimize estate taxes and reduce overall tax liability, making them an attractive option for those with significant cross-border assets.

A grantor retained annuity trust (GRAT), for example, allows foreign investors to minimize estate taxes while receiving a steady stream of income from the trust. Trusts can also facilitate the transfer of assets to heirs, helping to avoid probate and streamline the estate planning process. However, foreign investors need to understand the income tax consequences and estate tax implications of establishing a trust in the U.S., as well as the reporting requirements involved. Working with a tax professional or attorney who is experienced in cross-border estate planning can help foreign investors structure their trusts to protect assets, minimize estate taxes, and ensure compliance with all relevant laws. By leveraging the right trust structure, foreign investors can achieve their financial goals while safeguarding their wealth for the next generation.

Practical Steps for Foreign Investors Considering U.S. Trusts

1. Define your objective – Are you targeting U.S. assets? Foreign assets? Beneficiaries inside or outside the U.S.? Estate planning or asset protection?

2. Choose trustee, jurisdiction, and governing law carefully – U.S. law vs offshore trust law. For U.S. trusts, you’ll need to satisfy the court/control tests if you want to qualify it as a U.S. trust (or deliberately as a foreign trust), depending on your goal.

3. Select the correct trust type – Irrevocable non‑grantor trusts are often preferred for tax separation (grantor trusts mean the grantor is taxed).

4. Check asset location (situs) – U.S. vs non‑U.S. assets drastically change tax outcomes (for estate tax, income tax).

5. Review beneficiary status – Are the beneficiaries U.S. persons (citizen or resident) or foreign persons? Their tax status matters.

6. Consider U.S. trade or business involvement – If the trust engages in U.S. business, income may be effectively connected and taxable.

7. Plan for U.S. tax and reporting compliance – Filing of 3520/3520‑A, FBAR, and possibly 8938 (for specified foreign financial assets) if U.S. persons are involved.

8. Seek independent legal or tax advice – Before establishing a trust, consult with a qualified tax advisor or financial advisor to ensure your structure meets your objectives and complies with all relevant laws. This article does not provide legal or tax advice; always seek guidance from independent legal or tax professionals for your specific situation.

9. Revisit periodically – Tax laws change. Cross‑border structures must be reviewed annually.

10. Engage a cross‑border tax adviser – Given the complexity, you’ll need a professional who understands U.S. tax, trust law, estate tax, and your home country’s tax laws.

FAQs

If I’m a non‑U.S. investor, can I create a trust in the U.S. and avoid U.S. tax on the income of the trust?

Possibly—but only if the trust is structured so that the income is from non‑U.S. sources, the trust is non‑grantor, the beneficiaries are non‑U.S. persons, and the assets are non‑U.S. situs. If any U.S. source income or U.S. trade/business income exists, U.S. tax may apply. Also, trust classification (foreign vs domestic) matters.

If I hold U.S. real estate via a trust, can I avoid U.S. estate tax?

Holding U.S. real estate involves U.S. situs asset rules. One strategy is to hold U.S. real estate via a non‑U.S. corporation (owned by the trust) so that the underlying shares (non‑U.S. situs) are held, thus potentially avoiding estate tax. But careful planning is needed, and U.S. tax rules under FIRPTA and withholding apply.

Why not just use a foreign trust (jurisdiction outside the U.S.) and hold U.S. assets?

That is possible and often used—but it carries its own complexities: If a U.S. person is involved, or if U.S. beneficiaries exist, the foreign trust may trigger U.S. tax exposures (including gift tax, income tax at higher rates, and throwback rules).

What if I (a foreign person) am a beneficiary of a U.S. family trust?

The classification and tax consequences will depend on whether the trust is domestic or foreign, what the trust income is, whether the trust has U.S. source income, what treaty may apply, how distributions are made, and whether you are a U.S. person or a foreign person. Family members are often named as beneficiaries in family trusts, and their tax status can affect the trust's tax treatment. Trust taxation for foreign beneficiaries can become complex (with withholding, final distributions, and income character issues).