A foreign trust with a US grantor or US beneficiaries sits at the intersection of the most complex and most penalized areas of US international tax law. The reporting obligations are annual, the penalties are asset-based rather than income-based, and the compliance failures most commonly occur not because taxpayers are evading tax - but because they simply did not know the rules applied to them. This guide covers the full compliance framework for foreign trusts with US connections.
If any of the following describe your situation, this guide is directly relevant:
For US persons who receive foreign gifts or inheritances (not involving a trust), see our Form 3520 guide on foreign gifts which covers those thresholds and penalties.
Congress created two separate annual reporting forms for foreign trusts with US connections. They cover different parties and different information but are interrelated:
The most important - and most frequently misunderstood - rule in foreign trust taxation is IRC §679. Under §679, if a US person transfers property to a foreign trust that has (or could have) a US beneficiary, that US person is treated as the owner (grantor) of the trust for US income tax purposes. The result: all income, gain, deduction, and credit of the trust flows through to the US person's individual tax return, as if the trust were a US grantor trust.
IRC §679 applies regardless of:
A trust "has a US beneficiary" for §679 purposes if any US person could potentially benefit from the trust - even if no distribution has ever been made and even if the US person's interest is highly contingent. If the trust document grants the trustee discretion to distribute to any person in a class that includes US persons, the trust has US beneficiaries. If the trust can accumulate income and US persons could receive it in the future (including upon termination), the trust has US beneficiaries.
The only safe harbor: a trust where the trust agreement itself prohibits any benefit to a US person under any circumstance - and where an independent trustee has no power to change that restriction - will generally not be treated as having US beneficiaries. Most offshore trusts marketed to US persons do not meet this standard.
If a foreign trust is a grantor trust (whether because of §679 or otherwise), the US grantor pays US income tax on the trust's worldwide income at their ordinary individual tax rates - including income that remains inside the trust and is never distributed. The trust is transparent for US income tax purposes. IRC §671.
This means the US grantor needs the trust's complete financial information each year to prepare their tax return accurately. This is what Form 3520-A is designed to produce: an "Owner Statement" (Schedule B of Form 3520-A) that the trust prepares and provides to the US grantor, showing the grantor's share of trust income, deductions, and credits.
The US grantor (or deemed owner under §679) must file Form 3520 annually to report:
If the foreign trust does not have a US grantor - for example, it was established entirely by non-US persons with no US transfers - and it has US beneficiaries, the tax treatment shifts dramatically. The trust is now a foreign non-grantor trust, and its US beneficiaries face the throwback rules.
When a foreign non-grantor trust distributes income to a US beneficiary, the tax treatment depends on whether the distribution represents current-year income or accumulated prior-year income:
Undistributed Net Income (UNI) is the trust's accumulated DNI from prior years that has not yet been distributed. It is the pool from which accumulation distributions are drawn. Tracking UNI accurately requires maintaining complete records of the trust's annual DNI and all prior distributions - often for decades. Trustees of foreign non-grantor trusts with US beneficiaries should maintain UNI schedules from the trust's inception.
If a foreign trust makes a loan to a US grantor or US beneficiary, and the loan does not carry adequate interest (at least the applicable federal rate under IRC §1274(d)) and is not repaid within the year, the loan is treated as a distribution from the trust for income tax purposes. IRC §643(i). This creates an immediate income inclusion - potentially as an accumulation distribution if the trust has accumulated UNI - without the US person having actually received an economic distribution they can use to pay the tax.
The same treatment applies if a US person uses trust assets as collateral for a personal loan. The collateral pledge is treated as a deemed distribution of the value of the collateral.
Penalties under IRC §6677 can be abated if the taxpayer demonstrates "reasonable cause" for the failure to file and that the failure was not due to willful neglect. Treas. Reg. §301.6677-1. The IRS has historically granted reasonable cause abatement in cases where the taxpayer was genuinely unaware of the reporting obligation (common for recent immigrants with pre-existing foreign trusts) and promptly came into compliance once informed. The IRS is less forgiving where the taxpayer was represented by counsel or where offshore structures appear to have been designed to minimize tax.
US persons who failed to file Forms 3520 and 3520-A in prior years due to non-willful conduct can often come into compliance through the IRS Streamlined Filing Compliance Procedures. The Streamlined Domestic Offshore Procedures (for US-resident taxpayers) require filing amended returns for the most recent three years with all required international forms and paying a 5% miscellaneous offshore penalty on the highest aggregate account/asset balance. The Streamlined Foreign Offshore Procedures (for taxpayers who were non-residents) carry no miscellaneous penalty but require meeting the non-residency requirements.
For taxpayers with willful non-compliance, the Offshore Voluntary Disclosure Program (OVDP) was formally closed in 2018. Post-OVDP voluntary disclosure is handled through the IRS Criminal Investigation Voluntary Disclosure Practice, which provides reduced exposure to criminal prosecution but no capped civil penalty.