What Is a Foreign Trust? Court and Control Tests, Tax, and Forms

A foreign trust, for U.S. tax purposes, is any trust that fails to qualify as a domestic trust under the two-part test in the Internal Revenue Code. A trust is domestic only if a U.S. court can exercise primary supervision over its administration and U.S. persons control all of its substantial decisions. Fail either test and the trust is foreign, regardless of where its assets sit, where the grantor lives, or who benefits from it.¹ That classification carries real consequences: grantor-trust treatment for U.S. transferors, a deemed-sale exit tax when a domestic trust migrates, throwback tax on accumulated distributions to U.S. beneficiaries, and annual reporting on Forms 3520 and 3520-A with penalties that start at $10,000.

The Court Test and the Control Test

The classification works as a two-part gate. Passing one test but not the other still leaves the trust foreign.

The Court Test

A U.S. federal or state court must be able to exercise primary supervision over the trust’s administration: resolving disputes, removing or replacing trustees, and overseeing fiduciary conduct. A trust instrument that designates a foreign court as the exclusive forum, or specifies foreign governing law, can fail this test even when every asset and trustee is on U.S. soil.¹ Drafting is usually the deciding factor.

The Control Test

One or more U.S. persons must have the authority to control every substantial decision, with no other person holding veto power over any of them. Substantial decisions include when and how much to distribute, whether to allocate receipts to income or principal, and the power to add or remove trustees.²

A single foreign veto is enough to fail this test. Three U.S. trustees and one foreign trust protector who can block distributions produces a foreign trust. The regulations also make clear that the reverse doesn’t help: U.S. persons who merely hold veto power over a foreign decision-maker are not “controlling” the decision. They must be able to make it independently.²

When a Domestic Trust Accidentally Becomes Foreign

A trustee’s death, sudden resignation, or move abroad can flip a domestic trust to foreign status overnight by breaking the control test. Treasury regulations provide a 12-month grace period. If the change was inadvertent and the trust replaces the fiduciary or restores the residency of the relevant person within 12 months of the triggering event, the correction relates back to the date of the change and the trust is treated as having remained domestic the whole time.³

Miss the 12-month window and the residency change is retroactive to the date of the inadvertent event, which can trigger the exit tax described below. The IRS district director can grant additional time if the trust took reasonable steps but couldn’t finish the fix for reasons outside its control.³

What Foreign Status Means for a U.S. Transferor

Section 679: Grantor Treatment Is the Default

Under Section 679, any U.S. person who transfers property to a foreign trust is treated as the owner of the portion attributable to that transfer for income tax purposes, provided the trust has at least one U.S. beneficiary. All income generated by those assets flows onto the transferor’s personal return, even though the assets sit in a foreign trust the transferor no longer controls.⁴

The statute presumes every foreign trust has U.S. beneficiaries unless the transferor proves otherwise. Rebutting the presumption requires showing that no part of the trust’s income or principal can be paid to or accumulated for the benefit of any U.S. person, even upon termination. Naming a U.S. person as a contingent beneficiary is enough to leave the presumption in place. Only two narrow exceptions apply: transfers at death, and transfers where the U.S. person receives consideration equal to or exceeding the property’s fair market value.⁴

Section 684: The Exit Tax on Migration

When a domestic trust becomes a foreign trust, the tax code treats the trust as if it sold every asset at fair market value immediately before the status change. Gain equal to the difference between fair market value and adjusted basis must be recognized on each asset.⁵ A trust holding appreciated real estate or securities can face a substantial tax bill with no cash changing hands.

The same deemed-sale rule applies to any direct transfer of property by a U.S. person to a foreign trust or estate. An exception applies if the transferor is already treated as owner under the grantor trust rules, since that income is already on their return. A trust can also avoid the exit tax by qualifying for the 12-month inadvertent-change safe harbor and correcting the problem in time.⁶

How the Trust Itself Is Taxed

Foreign trusts fall into two categories with very different consequences.

A foreign grantor trust is disregarded as a separate entity for income tax. The grantor reports all income, deductions, and credits on their personal return.⁷ Section 679 forces this treatment in most cases where a U.S. person transfers property to a foreign trust with U.S. beneficiaries.

A foreign non-grantor trust is a separate taxable entity. It pays U.S. tax only on U.S.-source income or income effectively connected to a U.S. trade or business, similar to how a nonresident alien is taxed. U.S. beneficiaries who receive distributions report them as taxable income on their own returns.

The Throwback Rule on Accumulated Distributions

When a foreign non-grantor trust distributes income it accumulated in prior years rather than paying it out currently, U.S. beneficiaries face the throwback tax. Accumulated income is taxed as if it had been distributed in the year earned, and an interest charge is added for the delay.⁸

The beneficiary calculates the additional tax on Form 4970 and reports it through Part III of Form 3520. The interest charge compounds daily at the underpayment rate for periods after 1995.⁹ For a trust that has accumulated income over a decade or more, the combined tax and interest can consume much of the distribution. A beneficiary who lacks records to prove a distribution isn’t subject to the throwback rule may be taxed on it anyway.

Reporting: Forms 3520 and 3520-A

U.S. persons involved with a foreign trust face two primary reporting forms, and their deadlines don’t align.

Form 3520 is filed by the U.S. person to report transactions with the foreign trust: creating it, transferring property into it, and receiving distributions. It requires the fair market value of transferred assets, details of distributions, and identifying information for trustees and beneficiaries. It is due on the 15th day of the fourth month after the taxpayer’s tax year ends, so April 15 for calendar-year individuals. An approved income-tax extension carries the Form 3520 deadline to October 15.¹⁰

Form 3520-A is the annual return of the foreign trust itself when it has at least one U.S. owner. It includes a balance sheet, income statement, and statements to each U.S. owner and beneficiary. It is due on the 15th day of the third month after the trust’s tax year ends, so March 15 for calendar-year trusts.¹¹ The U.S. owner is responsible for making sure the trust files. If the trust doesn’t, the U.S. owner must complete a substitute Form 3520-A and attach it to their own Form 3520 by the Form 3520 due date to avoid a separate penalty.¹⁰

Both forms are mailed to the Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409.¹¹ Electronic filing isn’t available for either form as of 2026, though the IRS accepts electronic signatures.

A related but distinct requirement: Form 3520 is also used to report gifts or bequests from foreign persons above $100,000 in a tax year, even when no trust is involved.¹⁰

FBAR and FATCA May Also Apply

Foreign trust reporting doesn’t end with the 3520 series. A foreign trust holding bank or investment accounts abroad can trigger FBAR filing (FinCEN Form 114) for its U.S. owners when aggregate foreign account values exceed $10,000 at any point in the year.¹² Interests in foreign trusts are also specified foreign financial assets that may require Form 8938 under FATCA, filed with the income tax return.¹³

Penalties can be waived on a showing of reasonable cause and no willful neglect, supported by a written statement under penalties of perjury. The bar is high. The statute explicitly says that a foreign country’s civil or criminal penalties for disclosing trust information to the IRS are not reasonable cause.¹⁴ For continuing penalties assessed after an IRS notice, the agency considers what the taxpayer did after receiving the notice; ignoring it and claiming reasonable cause later rarely works.¹⁵

1
Office of the Law Revision Counsel. 26 USC 7701 – Definitions
2
eCFR. 26 CFR 301.7701-7 – Trusts, Domestic and Foreign
3
eCFR. 26 CFR 301.7701-7 – Trusts, Domestic and Foreign
4
Office of the Law Revision Counsel. 26 USC 679 – Foreign Trusts Having One or More United States Beneficiaries
5
Office of the Law Revision Counsel. 26 USC 684 – Recognition of Gain on Certain Transfers to Certain Foreign Trusts and Estates
6
eCFR. 26 CFR 1.684-4 – Outbound Migrations of Domestic Trusts
7
Office of the Law Revision Counsel. 26 USC 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners
8
Internal Revenue Service. Taxation of Beneficiary of a Foreign Non-Grantor Trust
9
Internal Revenue Service. Instructions for Form 3520
10
Internal Revenue Service. Instructions for Form 3520 (12/2025)
11
Internal Revenue Service. Instructions for Form 3520-A
12
Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR)
13
Internal Revenue Service. 26 USC 6677 – Failure to File Information With Respect to Certain Foreign Trusts
15
Internal Revenue Service. Failure to File the Form 3520/3520-A Penalties