ACTEC Trust & Estate Talk

Episode: "Taxation of Foreign Non-Grantor Trusts"

Date: October 14, 2025
Host: Travis Hayes (A), ACTEC Fellow
Guest: Brent Nelson (C), ACTEC Fellow

Episode Overview

This episode demystifies the complex U.S. tax rules that apply to foreign non-grantor trusts with U.S. beneficiaries or U.S.-situated assets. Brent Nelson shares practical frameworks and solutions for advisors, expatriates, and trustees to recognize risks and opportunities when global families encounter evolving cross-border circumstances.

Key Discussion Points and Insights

1. Why Foreign Non-Grantor Trust Taxation Matters

• Many cross-border families can unexpectedly trigger U.S. tax issues when a family member becomes a U.S. resident.
  • “It’s one of these topics that can arise without anybody really trying to do anything. It can just happen.” — Brent Nelson [01:14]

2. Hypothetical Family Scenario as an Analytical Framework

• Non-U.S. grandfather creates an irrevocable trust overseas with a foreign trustee.
• A grandchild later relocates to the U.S., turning an initially non-U.S. trust structure into a U.S. tax concern.
  • “All of a sudden one of the grandchildren moves to Miami...you have this scenario where the trust which used to have absolutely no contact with the U.S. is now connected to the U.S.” — Brent Nelson [01:43]

3. Defining a Foreign Trust (02:45)

• If a foreign trustee has substantial decision-making power, the trust is foreign—even if assets and beneficiaries are U.S.-based.

4. Grantor vs. Non-Grantor Trusts (03:10)

• With a foreign settlor, a trust is a foreign non-grantor trust except if:
  1. Settlor or spouse is the only possible distribution recipient during settlor’s life, or
  2. Settlor retains the power to revoke the trust.
• This distinction is crucial for determining U.S. tax exposure and compliance requirements.

5. Pre-Residency Planning Considerations (04:40)

• Importance of identifying the grandchild’s U.S. residency start date for U.S. income tax purposes.
• Trust structure can sometimes be modified before residency to achieve optimal tax results.
  • Separate trust shares for U.S. and non-U.S. beneficiaries may be beneficial.
  • Conversion of foreign company interests to avoid negative U.S. tax treatment through “check the box” regulations (IRC Section 7701).

6. Grantor Trust Outcomes

• If foreign grantor trust status is maintained:

  • Foreign grantor is the taxpayer, not the U.S. beneficiary.
  • U.S. beneficiary’s distributions are income-tax free if there’s no U.S. income in the trust.
    • “That is a pretty good result. So that might be the result we want to get.” — Brent Nelson [07:04]

• Alternatively, Section 678 power can “deem” the U.S. beneficiary as owner if structured properly.

7. Non-Grantor Trust Outcomes: The Throwback Rules (08:30)

• Throwback Rules:
  • Tax U.S. beneficiaries on distributions of accumulated trust income at ordinary rates.
  • Capital gains included in distributable net income (DNI) for foreign trusts—different from domestic rules.
  • Interest penalty for accumulated income: The longer income is retained, the harsher the penalty on future distributions.
    • “The interest charge, if this is accumulated income over a very long period of time, can be more than the tax amount and can be even more than that accumulated income amount.” — Brent Nelson [09:36]

8. Planning Solutions for Non-Grantor Trusts (10:00)

• Distribute only current DNI: Avoids penalties by not distributing accumulated income.
• Control trust accounting income: Use underlying entities or invest through insurance wrappers to regulate distributable income.
• Establish simple trust structure: All income is distributed annually; protects against throwback penalties but may increase creditor risk.
• Create separate shares: Limits negative consequences for U.S. beneficiaries.

9. Compliance and Reporting Traps (11:18)

• Primary U.S. forms:
  • Form 3520: Disclose foreign trust distributions/relationships.
  • Obtain "Foreign Non-Grantor Trust Beneficiary Statement" from trustee.
  • FBAR/FinCEN 114, Form 8938: Report foreign financial assets.
  • Form 5471 (CFCs) and Form 8621 (PFICs): For entity interests.
• Penalties: Harsh for non-compliance, including permanent extension of statute of limitations.
  • “Failure to comply with these reporting requirements can cause penalties which can be quite mean and bitter for the beneficiary to have to pay.” — Brent Nelson [11:42]

Memorable Quotes

• “Throwback rules are sort of like tonsils. You always hear what they are, but you have no idea what they do.”
  — Brent Nelson [08:43]

• “This is the world that our fund US beneficiary could be inheriting from Grandpa.”
  — Brent Nelson [12:05]

Timestamps for Important Segments

• 00:37 — Episode introduction and importance of the topic
• 01:14 — Setting up the hypothetical scenario
• 02:45 — What makes a trust a foreign trust
• 03:10 — Grantor vs. non-grantor trust status
• 04:40 — Planning opportunities and pre-residency strategies
• 07:04 — Grantor trust outcomes for U.S. beneficiaries
• 08:30 — Taxation of non-grantor trusts: DNI and throwback rules
• 09:36 — The impact of interest penalties on accumulated income
• 10:00 — Planning solutions for accumulating/distributed income
• 11:18 — Reporting, compliance, and penalties

Conclusion

Brent Nelson provides a clear, practical framework for professionals advising international families on the U.S. taxation of foreign non-grantor trusts. Careful pre-immigration planning, flexible trust structuring, awareness of the throwback rules, and diligent reporting are essential to avoid costly pitfalls. The episode underscores the complexity of cross-border trust taxation and the need for proactive attention whenever U.S. connections arise.