Distributions From a Foreign Trust: Reporting on Form 3520 Part III

1. Who Files Part III

The Form 3520 instructions direct a U.S. person who received a distribution from a foreign trust during the current tax year to complete Part III. Both grantor and non-grantor trusts are covered, and there is no dollar threshold. Distributions from a foreign trust are reported in Part III, not as gifts in Part IV, even when the family thinks of the money as a gift. An amount that would be reportable in both Parts is reported only in Part III.

Due date: the 15th day of the 4th month after the beneficiary’s tax year (April 15 for a calendar-year individual), June 15 for qualifying filers abroad, or October 15 with an income tax extension. An extension past October 15 doesn’t carry Form 3520 with it. See Form 3520 & 3520-A Due Dates by Year.
Penalty: under IRC § 6677(a), the greater of $10,000 or 35% of the gross amount of the distributions, subject to a reasonable-cause exception.
Check for an exemption first: Rev. Proc. 2020-17 exempts certain tax-favored foreign retirement and savings trusts from Form 3520 reporting. See Foreign Retirement Accounts & Form 3520.
Covered expatriates: a distribution attributable to a gift or bequest from a covered expatriate may also require Form 708. See the Section 2801 foreign trust rules.

2. Step One: Foreign Grantor or U.S. Grantor?

Grantor trust status drives everything that follows, and the rules are very different depending on who created and funded the trust.

Foreign grantor: § 672(f) narrows the rules

Under IRC § 672(f)(1), 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. For a nonresident alien grantor, the familiar triggers in §§ 673–677 (a power of substitution, discretionary distribution powers, administrative powers) generally do not make the trust a grantor trust. Only two exceptions in § 672(f)(2)(A) remain:

Revocable trust: 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 regulations require the power to be exercisable for at least 183 days of the trust's year (Treas. Reg. § 1.672(f)-3(a)).
Grantor-and-spouse trust: during the grantor's lifetime, the only amounts distributable are to the grantor or the grantor's spouse. Naming children as discretionary beneficiaries takes the trust outside this exception.

Narrow additional rules cover certain grandfathered trusts created on or before September 19, 1995, compensatory trusts, and, under § 672(f)(5), U.S. beneficiaries who made gifts to the foreign grantor.

U.S. grantor: the full rules apply

When a U.S. person creates or funds a foreign trust, the full grantor trust rules of §§ 673–677 apply, and IRC § 679 separately treats the U.S. transferor as the owner of a foreign trust that has, or may have, a U.S. beneficiary. That is the Form 3520-A world: the trust or its U.S. owner files Form 3520-A, and the owner reports on Form 3520. See the Form 3520-A Guide.

Practitioners used to domestic trusts sometimes assume a retained power of substitution makes a foreign family trust a grantor trust. For a foreign grantor, it generally does not.

When the foreign grantor dies

A foreign grantor trust generally becomes a foreign non-grantor trust when the grantor dies, because neither § 672(f)(2)(A) exception can apply after the grantor's death. Income the trust earns and does not distribute from that point forward can become undistributed net income, and later distributions to U.S. beneficiaries may carry it out as accumulation distributions. This transition is one of the most common ways U.S. families end up with a throwback problem they did not know they had.

3. Step Two: The Beneficiary Statements

The foreign trustee's statement determines how much of the computation the beneficiary can do on actual figures. Part III asks (lines 29 and 30) whether the beneficiary received a complete statement, and the instructions say that if any required item is missing, the answer is "No."

Foreign Grantor Trust Beneficiary Statement (page 5 of Form 3520-A). Among other items: the trust's tax year, the facts showing that another person is treated as the owner, the type of owner, a description and fair market value of the property distributed, a commitment to make records available for inspection, and information about the trust's U.S. agent.
Foreign Nongrantor Trust Beneficiary Statement. Among other items: an explanation of the appropriate U.S. tax treatment of the distribution (or enough information to determine it), whether any grantor is a partnership or foreign corporation, and the same inspection commitment and agent information.

With a complete Foreign Grantor Trust Beneficiary Statement, the beneficiary attaches it and does not complete the rest of Part III for that distribution. The instructions say to treat the distribution for income tax purposes as if it came directly from the owner: if it is a gift, it is not included in gross income.

Many foreign trustees have never prepared either statement. Requesting one early, with the instructions' list of required items attached, is often the single most useful step in the engagement.

4. Step Three: Default Method or Actual Method

Default method (Schedule A, lines 31–38)

Required when there is no complete beneficiary statement; optional when there is a complete Foreign Nongrantor Trust Beneficiary Statement. The beneficiary enters the current-year distributions, the number of years the trust has been a foreign trust (any part of a year counts as a full year), and distributions received in the three preceding years. The portion of the current distribution up to 125% of the prior-years average is reported as ordinary income (line 36). Anything above that is an accumulation distribution (line 37), which requires Schedule C.

Two points from the instructions: years with no distributions are not disregarded in the average, and in the first year the trust is a foreign trust, the rest of Part III is not completed.

Actual method (Schedule B, lines 39–47)

Uses the figures in a Foreign Nongrantor Trust Beneficiary Statement to divide the distribution among current-year income (by character), principal, and accumulation distributions of prior years' undistributed income.

The instructions limit Schedule B to beneficiaries who attach the statement and who have never used Schedule A for that trust, or whose trust terminated during the year. Generally, once the default method is used for a trust, it must be used for all future years, which makes the first year's choice a long-term one.

Example: a large distribution under the default method

A non-grantor trust that has been foreign for many years distributed $20,000 to a U.S. beneficiary in each of 2022, 2023 and 2024 ($60,000 total). In 2025 it distributes $300,000, and the trustee provides no statement.

125% of prior distributions: $75,000; divided by 3: $25,000, reported as ordinary income.
The remaining $275,000 is an accumulation distribution, taxed under the throwback rules with an interest charge.

With a complete nongrantor beneficiary statement and the actual method, much of the same $300,000 might instead be current income or principal, depending on the trust's records. The difference can be very large.

5. Accumulation Distributions, the Throwback Tax and the Interest Charge

When a foreign non-grantor trust distributes income accumulated in earlier years, the throwback rules of IRC §§ 665–668 tax it as if it had been distributed in those earlier years, using an averaging computation over the beneficiary's prior years. Under the Form 3520 instructions, the computation works as follows:

Schedule C is completed when there is an amount on line 37 (default method) or line 41a (actual method).
The accumulation distribution is carried to line 1 of Form 4970, Tax on Accumulation Distribution of Trusts, and the tax is computed on Form 4970. The instructions say to use Form 4970 as a worksheet and attach it to Form 3520.
An interest charge under § 668 runs on that tax for a period measured by the applicable number of years. The instructions point to the combined interest rate table on IRS.gov for the rate. Preparers should check the factor rather than rely on it uncritically, because published tables have not always matched the underlying quarterly underpayment rates.
The total from Schedule C (line 53) is reported as additional tax on the beneficiary's income tax return. For Form 1040 filers, it is included in the "Any other taxes" line on Schedule 2.

Capital gains accumulated in a foreign non-grantor trust generally do not keep their character when carried out as an accumulation distribution, so long-held gains can end up taxed as ordinary income plus interest. Combined with the interest charge, the throwback computation can absorb a large share of a distribution from a trust that accumulated income for many years.

The computation needs the beneficiary's taxable income and tax for the prior years in the averaging period. Gathering that history, along with the trust's own distribution and income records, early in the engagement saves time.

6. Loans and Use of Trust Property (§ 643(i))

Under IRC § 643(i), a loan of cash or marketable securities from a foreign trust to a U.S. beneficiary, or to a U.S. person related to the beneficiary, and the use of trust property by such a person, are treated as distributions. The instructions say these amounts are reportable distributions on Part III whether or not they are taxable.

Loans: the qualified obligation exception

A loan is not treated as a distribution if it is a qualified obligation. The instructions list the requirements, including that the obligation is in writing, its term does not exceed 5 years (including renewals and rollovers), all payments are denominated in U.S. dollars, the yield falls within a range tied to the applicable federal rate, the U.S. person agrees to extend the period of assessment, and the status of the obligation is reported each year it is outstanding.

Use of trust property

When a U.S. beneficiary or related U.S. person uses trust property, such as living in a trust-owned residence, the fair market value of the use is treated as a reportable distribution. Part III reports the value of the use, any amount paid for it, and the difference. Paying fair market value for the use is the usual way to keep the net amount at zero.

7. Indirect Distributions

A distribution does not have to arrive directly from the trust. Amounts paid through an intermediary or nominee can be treated as distributions from the trust (Treas. Reg. § 1.643(h)-1), and payments the trust makes on a beneficiary's behalf, such as tuition, rent or credit card bills, are distributions to that beneficiary. Ask about these specifically. Clients often think only of money that landed in their own account.

8. Common Fact Patterns

Situation	Likely status	Key points
Living parent's revocable offshore trust distributes to a U.S. child	Foreign grantor trust, if the § 672(f)(2)(A) revocation test is met	Report in Part III with the grantor beneficiary statement; generally not taxable income to the child
Same trust after the parent's death	Foreign non-grantor trust	Income accumulated after death can become UNI; request a nongrantor statement before the first distribution
Discretionary trust, irrevocable, children are beneficiaries, foreign grantor alive	Usually non-grantor, despite retained powers	Neither § 672(f) exception applies; a power of substitution does not change that
First large distribution from a long-standing non-grantor trust, no statement	Default method	Most of the distribution may be an accumulation distribution; the default method then applies in future years
U.S. beneficiary lives rent-free in a trust-owned apartment	§ 643(i) use of property	Fair rental value is a reportable distribution unless paid
Trust lends a U.S. child funds for a home purchase	§ 643(i) loan	Treated as a distribution unless the loan meets every qualified obligation requirement

Trust characterization depends on the trust instrument and the facts. The table is a starting point for analysis, not a conclusion.

9. Preparing Part III

Gather first: the trust instrument, the trustee's beneficiary statement, a schedule of all distributions (including indirect payments, loans and use of property), and the trust's history as a foreign trust.
For the default method: the distributions received in each of the three preceding years.
For accumulation distributions: the beneficiary's taxable income and tax for the prior years used in the Form 4970 computation.
Attach: the beneficiary statement and, where Schedule C applies, Form 4970 as a worksheet.
Carry to the 1040: ordinary income from line 36 or Schedule B, and the Schedule C total as additional tax on Schedule 2.
Reconcile: keep Part III consistent with the income tax return, Form 8938, and FBARs for the same year.
Missed years: see Late Form 3520 or 3520-A: Streamlined vs. Delinquent Procedures and Form 3520 Penalty Relief & Reasonable Cause.

10. Frequently Asked Questions (FAQ)

Is a distribution from a foreign trust taxable to a U.S. beneficiary?

It depends on the trust. A distribution from a foreign grantor trust is generally not taxable income to the beneficiary, although it must still be reported on Form 3520 Part III. A distribution from a foreign non-grantor trust may be taxable as current-year income, and any portion that is an accumulation distribution of prior years' income is taxed under the throwback rules with an interest charge.

What happens if the foreign trustee will not provide a beneficiary statement?

Without a complete Foreign Grantor or Foreign Nongrantor Trust Beneficiary Statement, the beneficiary uses the default method on Schedule A of Part III. The portion of the distribution up to 125% of the average distributions from the three preceding years is reported as ordinary income, and the excess is an accumulation distribution. Under the Form 3520 instructions, once the default method is used for a trust, it generally must be used for all future years; the only exception is the year the trust terminates, if a complete nongrantor statement is available.

What is the throwback tax on foreign trust distributions?

The throwback rules of IRC sections 665 through 668 tax an accumulation distribution of a foreign non-grantor trust's prior-years income as if it had been distributed in those earlier years, using an averaging computation on Form 4970. An interest charge under section 668 is added. The Form 3520 instructions direct beneficiaries to use Form 4970 as a worksheet attached to Form 3520 and to report the Schedule C total as additional tax on the income tax return.

Does a loan from a foreign trust have to be reported on Form 3520?

Yes. Under IRC section 643(i), a loan of cash or marketable securities from a foreign trust to a U.S. beneficiary or related U.S. person is treated as a distribution and reported on Part III, unless it is a qualified obligation. The requirements include a written agreement, a term of no more than 5 years, U.S. dollar payments, a yield tied to the applicable federal rate, an agreement to extend the assessment period, and annual reporting of the obligation's status.

What changes when the foreign grantor of a trust dies?

A foreign grantor trust generally becomes a foreign non-grantor trust when the grantor dies, because the exceptions in IRC section 672(f)(2)(A) for revocable trusts and grantor-and-spouse trusts no longer apply. Income the trust earns and does not distribute after that point can become undistributed net income, and later distributions to U.S. beneficiaries may be accumulation distributions subject to the throwback tax.

Is there a minimum distribution amount that triggers Form 3520 Part III reporting?

No. The Form 3520 instructions require a U.S. person who received a distribution from a foreign trust during the tax year to complete Part III, without a dollar threshold. Loans and the use of trust property can also be reportable distributions. The penalty for failing to report is the greater of $10,000 or 35% of the gross amount of the distributions under IRC section 6677(a).