1. What "Grantor Trust" Means
A grantor trust is a trust, or a portion of one, whose income is taxed to someone other than the trust. Under IRC § 671, the person treated as the owner reports the trust's income, deductions and credits on their own return as if the trust did not exist for income tax purposes. A nongrantor trust has no owner: it is a separate taxpayer, and its beneficiaries are taxed when income is distributed to them.
For a foreign trust, the difference decides almost everything about U.S. reporting. A U.S. owner is taxed on the trust's worldwide income every year and must see that Form 3520-A is filed. A foreign nongrantor trust is generally taxed by the United States only on its U.S.-source and effectively connected income, and its U.S. beneficiaries are taxed when they receive distributions, including accumulated income under the throwback rules.
- Who is a grantor: any person, to the extent the person creates a trust or directly or indirectly makes a gratuitous transfer of property to it (Treas. Reg. § 1.671-2(e)(1)). If one person funds a trust on behalf of another, both are grantors. A person who creates a trust but transfers nothing to it is not an owner.
- Gratuitous transfer: any transfer other than one for fair market value, whether or not it is a gift for gift tax purposes (Treas. Reg. § 1.671-2(e)(2)).
- Portion by portion: ownership is tested separately for each portion of a trust. One trust can have a portion owned by a U.S. person, a portion owned by a foreign person, and a nongrantor portion. The Form 3520 instructions define a grantor trust as a trust "to the extent" its assets are treated as owned by a person other than the trust.
- Owner, not just grantor: the question is always whether someone is treated as the owner under §§ 671–679. A grantor is usually the owner, but § 678 can make someone else the owner, and § 672(f) can mean a foreign grantor is not.
2. The Classification, Step by Step
Work through these questions in order, for each portion of the trust and for each year. The answer can change from year to year.
- Is it a trust? An arrangement whose purpose is to protect or conserve property for beneficiaries is a trust; one that carries on a business for profit is usually a business entity (Treas. Reg. § 301.7701-4). Foreign foundations, pension arrangements and savings accounts need this analysis first. Some foreign retirement and savings trusts are exempt from Form 3520 under Rev. Proc. 2020-17.
- Is it a foreign trust? See section 3.
- Did a U.S. person transfer property to it? If so, that portion is tested under §§ 673–677 and § 679. See section 4.
- Was the property transferred by a foreign person? If so, § 672(f) applies. See section 5.
- Is anyone else an owner? Check § 678 and § 672(f)(5). See section 6.
- Has anything changed? A death, a move to or from the United States, a new beneficiary or a change of trustee can change the answer. See section 7.
If no one is treated as the owner of a portion, that portion is a nongrantor trust.
3. Step One: Is the Trust Foreign?
A trust is domestic only if it meets both tests in IRC § 7701(a)(30)(E) and Treas. Reg. § 301.7701-7 on that day. Every other trust is a foreign trust, wherever it was formed and whatever it calls itself.
- Court test: a court within the United States can exercise primary supervision over the trust's administration. A court in a U.S. territory or a foreign country does not count.
- Control test: one or more U.S. persons have authority to control all substantial decisions of the trust. One foreign trustee or protector with a veto over a substantial decision, such as whether and when to distribute, is enough to fail it.
The control test catches U.S.-drafted trusts. A domestic trust that appoints a foreign trustee with power over distributions becomes a foreign trust on that date, which can trigger § 679 for a living U.S. transferor (section 7). After an inadvertent change, such as a U.S. trustee's death, incapacity or resignation, the trust has 12 months to restore U.S. control before its residency changes (§ 301.7701-7(d)(2)).
4. Step Two: Property From a U.S. Person
When a U.S. person transfers property to a foreign trust, two sets of rules can make that person the owner of the portion attributable to the transfer. Either is enough.
The ordinary grantor trust rules (§§ 673–677)
The same rules that apply to domestic trusts: a reversionary interest, certain powers to control beneficial enjoyment, administrative powers, a power to revoke, or income that may be distributed to the grantor or the grantor's spouse (IRC §§ 673–677). A self-settled trust, where the U.S. person can benefit, is almost always owned under § 677.
Section 679: a foreign trust with a U.S. beneficiary
A U.S. person who transfers property to a foreign trust is treated as the owner of the portion attributable to that property for any year in which the trust has a U.S. beneficiary (IRC § 679(a)(1); Treas. Reg. § 1.679-1(a)). It applies whether or not the transferor kept any power or interest, and it takes priority over § 678 (§ 1.679-1(b)). It applies to any U.S. person, including corporations and partnerships.
When does a foreign trust have a U.S. beneficiary?
Almost always, unless the trust instrument rules it out. The test is made each year (Treas. Reg. § 1.679-2(a)(1)). The trust is treated as having a U.S. beneficiary unless, during the transferor's tax year, no income or corpus may be paid or accumulated for a U.S. person, and none could be paid to a U.S. person if the trust terminated (IRC § 679(c)(1)).
- Possibility, not payment: it does not matter whether anything is actually distributed, or whether the U.S. person's interest is contingent on a future event (§ 1.679-2(a)(2)(i)).
- Discretion to add beneficiaries: if anyone can make distributions to persons chosen at their discretion, the trust has a U.S. beneficiary unless the instrument specifically identifies the class of permitted beneficiaries and none of them is a U.S. person that year (§ 679(c)(4)).
- Side agreements: any written or oral agreement or understanding involving the transferor that may result in a benefit to a U.S. person is treated as a term of the trust (§ 679(c)(5)).
- Loans and use of property: a loan of cash or marketable securities, or the use of other trust property, to or by any U.S. person is treated as a benefit to a U.S. person unless repaid at a market rate of interest or paid for at fair market value within a reasonable period (§ 679(c)(6)).
- Through entities: amounts for a controlled foreign corporation, a foreign partnership with a U.S. partner, or a foreign trust or estate with a U.S. beneficiary count as amounts for a U.S. person (§ 679(c)(2)).
- Later U.S. persons: a beneficiary who first became a U.S. person more than 5 years after the transfer is disregarded for that transfer (§ 679(c)(3)).
- Remote contingencies: a person who is not named and is not in a class of beneficiaries can be disregarded if the transferor shows the interest is so remote as to be negligible. This does not help when a trustee or anyone else has discretion to pay that person (§ 1.679-2(a)(2)(ii)).
- Burden on the transferor: the IRS may treat the trust as having a U.S. beneficiary unless the transferor provides information showing it does not (§ 679(d)).
Exceptions and what counts as a transfer
- Excepted transfers (Treas. Reg. § 1.679-4(a)): transfers by reason of the transferor's death; transfers to trusts described in §§ 402(b), 404(a)(4) or 404A; transfers to a trust described in § 501(c)(3); and transfers for fair market value, to the extent of the value received. An interest in the trust is not consideration, and the trust's own obligations or those of related persons are generally disregarded (§ 1.679-4(b)–(d)).
- Indirect and constructive transfers (Treas. Reg. § 1.679-3): a transfer through an intermediary, paying or assuming the trust's obligation to a third party, guaranteeing a trust borrowing, or (for a related U.S. person) a transfer to an entity the trust owns can be a transfer to the trust.
In practice, a foreign trust that a U.S. person funded for family members who are, or may become, U.S. persons is a grantor trust with that U.S. person as owner. The trust files Form 3520-A, and the owner reports in Part II of Form 3520 every year. See the Form 3520-A Guide and the substitute Form 3520-A guide.
5. Step Three: Property From a Foreign Person
When the grantor is a nonresident alien or other foreign person, IRC § 672(f)(1) applies: the grantor trust rules apply only to the extent they result in income being taken into account by a U.S. citizen or resident or a domestic corporation. So the powers that make a domestic trust a grantor trust usually do not make a foreign person the owner. Only these exceptions remain:
- Revocable trust (§ 672(f)(2)(A)(i)): the grantor can revest title in himself or herself, alone or with the consent only of a related or subordinate party subservient to the grantor. The power must be exercisable for at least 183 days of the trust's year (Treas. Reg. § 1.672(f)-3(a)).
- Grantor-and-spouse trust (§ 672(f)(2)(A)(ii)): during the grantor's lifetime, the only amounts distributable, of income or corpus, are to the grantor or the grantor's spouse (§ 1.672(f)-3(b)).
- Narrow cases: certain compensatory trusts (§ 1.672(f)-3(c)) and trusts grandfathered as of September 19, 1995, to the extent of earlier contributions.
If an exception applies, the trust is a foreign grantor trust with a foreign owner. It files no Form 3520-A, because it has no U.S. owner. A U.S. beneficiary who receives a distribution reports it in Part III of Form 3520, and with a complete Foreign Grantor Trust Beneficiary Statement treats it as coming directly from the owner; a gift from the owner is not income.
If no exception applies, which is the usual case for an irrevocable discretionary trust for children or grandchildren, the portion is a nongrantor trust, even if the foreign grantor kept a power of substitution or other powers. U.S. beneficiaries report distributions in Part III using a Foreign Nongrantor Trust Beneficiary Statement or the default method. See Distributions From a Foreign Trust: Form 3520 Part III.
6. Step Four: Owners Other Than the Grantor
U.S. beneficiary who made gifts to the foreign grantor (§ 672(f)(5))
If a foreign person would be the owner but for § 672(f)(5), a U.S. beneficiary is treated as the grantor of a portion to the extent the beneficiary made gratuitous transfers to that foreign person, net of transfers back. Gifts excluded under the § 2503(b) annual exclusion are not counted, and the rule does not apply if the beneficiary shows the transfer was wholly unrelated to the trust (IRC § 672(f)(5); Treas. Reg. § 1.672(f)-5(a)). This stops a U.S. person from routing money through a foreign relative's trust.
Holder of a power to vest income or corpus (§ 678)
A person other than the grantor who has a power, exercisable alone, to vest the corpus or income in himself or herself is treated as the owner of that portion (IRC § 678(a)). A U.S. beneficiary with an unrestricted withdrawal right is the typical case. § 678 gives way when a § 679 transferor owns the same portion (Treas. Reg. § 1.679-1(b)), and § 672(f) limits it for a foreign holder. For how § 678 affects gift reporting, see Form 3520 gift thresholds.
7. When the Classification Changes
Classification is annual. These events change it most often:
| Event | What changes | Authority |
|---|---|---|
| Foreign grantor dies | Neither § 672(f)(2)(A) exception can apply after death, so a foreign grantor trust generally becomes a nongrantor trust. Income accumulated from then on can become undistributed net income and later be taxed to U.S. beneficiaries under the throwback rules. | § 672(f)(2)(A) |
| U.S. owner dies | The decedent stops being an owner. Unless someone else is an owner, the portion is a nongrantor trust from then on. The death is a reportable event: the executor reports it in Part I of Form 3520. | Form 3520 instructions (Responsible Party; Reportable Event) |
| Foreign grantor becomes a U.S. resident within 5 years of a transfer | The individual is treated as transferring the trust property again on the residency starting date, including attributable undistributed net income. With a U.S. beneficiary, § 679 makes the new resident the owner. | § 679(a)(4); Treas. Reg. § 1.679-5 |
| A nonresident owner stops being an owner, then becomes a U.S. resident within 5 years | The original transfer is treated as made immediately before ownership ended, so the 5-year period runs from then. | Treas. Reg. § 1.679-5(b)(1) |
| Domestic trust becomes a foreign trust while the U.S. transferor is alive | For example, by appointing a foreign trustee with power over distributions. The transferor is treated as transferring the trust property to a foreign trust on that date, including attributable undistributed net income. | § 679(a)(5); Treas. Reg. § 1.679-6 |
| Trust gains a U.S. beneficiary | § 679 applies from that year. The U.S. transferor also includes in income the trust's undistributed net income attributable to the transfer, as of the end of the prior year. | § 679(b); Treas. Reg. § 1.679-2(c)(1) |
| Trust no longer has a U.S. beneficiary | The U.S. transferor stops being the § 679 owner beginning the following year, unless §§ 673–677 still apply. | Treas. Reg. § 1.679-2(c)(2) |
The § 679 regulations apply to transfers after August 7, 2000, and the pre-immigration and outbound migration rules to residency starting dates and migrations after that date (Treas. Reg. § 1.679-7).
8. What Each Classification Means for Filing
Classification decides which Parts of Form 3520 apply, whether Form 3520-A is filed, and which trust statements exist. Transfers to a foreign trust by a U.S. person are reported in Part I whatever the classification.
| Classification | Form 3520-A | Owner | U.S. beneficiaries |
|---|---|---|---|
| Grantor trust, U.S. owner (§ 679 or §§ 673–677) | Filed by the trust, or a substitute attached to the owner's Form 3520. Owner Statement to each U.S. owner; Beneficiary Statement (page 5) to each U.S. beneficiary who received a distribution. | Taxed on the trust's income each year. Part II every year, even with no transactions. A distribution to the owner from the owned portion goes on Part III lines 24 and 27 only. | Part III, line 29. With a complete statement, the distribution is treated as coming from the owner. |
| Grantor trust, foreign owner (§ 672(f)(2)) | Not filed. | Not a U.S. taxpayer on the trust's income. | Part III, line 29, with a Foreign Grantor Trust Beneficiary Statement the trust prepares itself. A gift from the owner is not income. |
| Nongrantor trust | Not filed. | None. | Part III, line 30. Schedule B (actual method) with a complete Foreign Nongrantor Trust Beneficiary Statement; otherwise Schedule A (default method). Accumulation distributions go to Schedule C. |
| Mixed portions | Filed if any portion has a U.S. owner, for that portion. | Each owner reports their own portion. | Each distribution follows the portion it comes from. |
For the three trust statements and how they relate to lines 29 and 30, see the three trust statements. For due dates, see Form 3520-A Is Due March 15.
9. Common Fact Patterns
| Situation | Likely classification | Why |
|---|---|---|
| U.S. citizen funds an offshore trust for her children, who live in the United States | Grantor trust; the U.S. citizen is the owner | § 679: the children are U.S. beneficiaries. It does not matter that the trust is irrevocable or that she kept no powers. |
| U.S. citizen funds an offshore trust; the deed names only nonresident relatives and bars additions | May have no U.S. beneficiary that year | § 679 may not apply, but check §§ 673–677, any side understandings, loans or use of property, and the § 679(d) presumption. If a U.S. beneficiary appears later, § 679(b) applies. |
| U.S. person's self-settled asset protection trust abroad | Grantor trust; the U.S. person is the owner | § 677 (the grantor can benefit) and usually § 679 as well. |
| Living foreign parent's revocable trust for a U.S. child | Grantor trust with a foreign owner | § 672(f)(2)(A)(i), if the 183-day revocation test is met. No Form 3520-A. |
| Foreign parent's irrevocable discretionary trust for children and grandchildren | Nongrantor trust | Neither § 672(f)(2) exception applies, whatever powers the parent kept. |
| Same revocable trust after the foreign parent dies | Nongrantor trust | The § 672(f)(2) exceptions end at death. |
| U.S. child sends money to a foreign parent, who funds a trust for the child | U.S. child may be the grantor of a portion | § 672(f)(5), to the extent of the child's gratuitous transfers above the annual exclusion. |
| Nonresident funds a foreign trust, then moves to the United States 3 years later | Grantor trust with the new resident as owner, if there is a U.S. beneficiary | § 679(a)(4): deemed transfer on the residency starting date. |
| Domestic trust names a foreign trustee who controls distributions | Becomes a foreign trust; § 679 for a living U.S. transferor | Fails the control test; § 679(a)(5) deemed transfer on that date. |
10. Documenting the Conclusion
- Gather: the trust deed and every amendment, any letter of wishes, the history of contributions (who, when, what, and for what consideration), the residency history of each contributor and beneficiary, the identity and powers of each trustee and protector, and any loans to or use of trust property by U.S. persons.
- Work portion by portion: trace each contribution to its transferor and test that portion separately.
- Write it down: keep a memo in the workpapers naming the Code section relied on and the facts that support it. The trust's beneficiary statements must state the same facts (for a grantor trust, the facts establishing the owner and the Code section).
- Ask the trustee early: the trustee's view, and whether it will provide Form 3520-A or a beneficiary statement, often decides how the return can be prepared.
- Revisit each year: deaths, moves, new beneficiaries, trustee changes and loans can all change the result.
In Agena's Form 3520 workspace, the preparer records for each Part III distribution whether the trust is a grantor or nongrantor trust, and the Form 3520-A workspace requires at least one U.S. owner. The software applies the reporting rules that follow from the classification; the classification itself is the preparer's judgment.
12. Frequently Asked Questions (FAQ)
Is a foreign trust created by a U.S. person always a grantor trust?
Usually, but not always. Under IRC § 679, a U.S. person who transfers property to a foreign trust is treated as the owner of the portion attributable to that property for any year the trust has a U.S. beneficiary, and the test is broad: a contingent or possible U.S. beneficiary is enough. If the trust truly cannot benefit any U.S. person, § 679 does not apply for that year, but the transferor can still be the owner under §§ 673–677, for example if the trust is revocable. Transfers for fair market value, transfers by reason of death, and certain compensation and charitable trusts are excepted (Treas. Reg. § 1.679-4).
Can a foreign trust be partly a grantor trust and partly a nongrantor trust?
Yes. Grantor trust status is determined portion by portion. Each person who creates a trust or makes a gratuitous transfer to it is a grantor of the portion attributable to that transfer (Treas. Reg. § 1.671-2(e)). A trust funded by a U.S. person and by a foreign relative can have a § 679 portion owned by the U.S. person and a nongrantor portion. Distributions are traced to the portion they come from.
Does a retained power of substitution make a foreign parent's trust a grantor trust?
Generally not. Under IRC § 672(f)(1), the grantor trust rules apply only to the extent they cause income to be taken into account by a U.S. citizen or resident or a domestic corporation. For a foreign grantor, only the § 672(f)(2) exceptions remain: a trust the grantor can revoke, or a trust that during the grantor's lifetime can distribute only to the grantor or the grantor's spouse. A power of substitution, or other powers under §§ 673–677, does not make the trust a grantor trust for a foreign grantor.
What happens when a nonresident moves to the United States after funding a foreign trust?
If the individual's residency starting date is within 5 years after the transfer, IRC § 679(a)(4) and Treas. Reg. § 1.679-5 treat the individual as transferring the trust property to the trust again on the residency starting date. If the trust has a U.S. beneficiary, the new resident becomes its owner under § 679, and Form 3520 and Form 3520-A reporting begins. The amount deemed transferred includes undistributed net income attributable to the original transfer.
Does a foreign nongrantor trust file Form 3520-A?
No. Form 3520-A is filed only by a foreign trust that has a U.S. owner. A nongrantor trust, and a grantor trust whose only owner is a foreign person, file no Form 3520-A. U.S. beneficiaries who receive distributions report them on Form 3520, Part III. See the three trust statements.
Preparing Form 3520 or 3520-A for a Foreign Trust?
Agena Software prepares Form 3520 Parts I through IV and Form 3520-A, including substitute returns and Owner and Beneficiary Statements, with checks that follow from the trust's classification.