Foreign grantor trusts after the grantor dies

A foreign trust's tax status may change when its grantor dies, which can affect income, distributions and reporting for U.S. citizens.

How grantor status ends

A foreign grantor trust generally stops being a grantor trust when its grantor dies. Grantor status may also end earlier if the conditions for treating the grantor as the owner no longer apply. Grantor status is an income tax classification under which the trust is treated as owned by the grantor for income tax purposes while that status applies.^[1]^[10]

For a non-U.S. grantor, a trust that qualified under either of two conditions ceases to qualify when the grantor dies. Three exceptions can permit grantor status for a nonresident noncitizen grantor, including a revocation power and a lifetime beneficiary condition. The trust's prior qualification therefore depends on the relevant facts and applicable rule.^[3]^[6]

A revocable trust's status can also end before death if the grantor gives up the power to revoke, changes the trust in specified ways, or transfers it into nongrantor status. The grantor's death is one of several events that can end a revocable trust's grantor trust status.^[5]

Income after the change

After the status change, the foreign trust is generally treated as a separate taxpayer for income tax purposes. For a nonresident noncitizen grantor, the trust recognizes taxable income from U.S. sources as an independent taxpayer after the grantor dies. U.S. beneficiaries are then taxed on distributions from the foreign trust.^[6]^[8]

Income and gains distributed to U.S. family members in the year realized generally are taxed to them as if they had arisen directly to those recipients. When income or gains are retained and distributed in a later year, the amounts may be treated as undistributed net income under the throwback rules. Such amounts generally may be taxed at ordinary income rates, including amounts that began as capital gains, with an additional interest charge tied to the accumulation period.^[1]

For a nonresident alien grantor, income accrued after the grantor's death, accumulated in the foreign trust, and later distributed to a U.S. beneficiary is taxed to that beneficiary.^[9]

For a U.S. grantor, there are separate possible consequences for trust assets at death. The outcome depends on whether the assets are included in the grantor's gross estate: a deemed sale can apply to assets not included, while included assets are not subject to that deemed sale and receive a fair market value basis adjustment. These asset rules are distinct from the change in grantor status.^[10]

Distributions and U.S. reporting

A U.S. person receiving a distribution from a foreign trust has a reporting event. Form 3520 is used to report the distribution, including the trust's name, the amount received, and its character. This reporting applies even when the recipient claims the distribution is not taxable because it came from a grantor trust or a trust without income.^[9]

The distribution reporting rule applies when the U.S. person knows or has reason to know that the trust is foreign. Beneficiary statements and distribution records may establish how a distribution is treated. Those records matter because a distribution may be treated as an accumulation distribution when adequate information is unavailable.^[9]

For a U.S. grantor, death is its own reportable event on Form 3520 if the decedent was treated as owner of any portion of the foreign trust or any portion is included in the gross estate. For a non-U.S. grantor, death itself does not create a Form 3520 reporting event the way a distribution does. Form 3520 reporting applies to distributions received by a U.S. person, while a grantor's death generally ends grantor status and affects the tax treatment of later income. A grantor's death generally is not treated as an income tax event when grantor status lapses, though practitioners do not all agree.^[9]^[12]

Questions and answers

Does a foreign grantor trust stay a grantor trust after the grantor dies?

Grantor status ends when the grantor dies, and the trust automatically converts to foreign nongrantor status.^[1]^[3]

Can grantor status end before the grantor dies?

Yes. For a foreign trust with a U.S. grantor, grantor status ends at the earlier of the grantor's death or the trust no longer having a U.S. beneficiary. A revocable trust's grantor trust status can end when the grantor renounces the power to revoke, makes suitable amendments, decants to a nongrantor trust, or dies.^[5]^[10]

Who recognizes U.S.-source income after a nonresident noncitizen grantor dies?

After the grantor's death, the trust recognizes U.S.-source income as an independent taxpayer, and U.S. beneficiaries are taxed on distributions from the trust.^[6]^[8]

How can accumulated income affect later distributions?

Income or gains accumulated and distributed in a later year may be subject to throwback treatment as undistributed net income and generally taxed at ordinary income rates, with an additional interest charge.^[1]

What U.S. form does a beneficiary use to report a foreign trust distribution?

A U.S. person who receives a distribution from a foreign trust reports it to the IRS on Form 3520, including the trust name, amount, and characterization of the distribution.^[9]

Is the grantor's death treated as an income tax event?

One view is that death generally is not treated as an income tax event when grantor status lapses, although there is no universally agreed answer.^[12]

Related glossary terms

Foreign grantor trust beneficiary statement: A foreign grantor trust beneficiary statement appears on page 5 of Form 3520-A. It reports distributions to U.S. beneficiaries and identifies the trust's owner.
Income for the benefit of the grantor: Section 677 treats a grantor as owner of a trust portion when income can benefit the grantor or spouse, including through certain life insurance premiums.
U.S. owner of a foreign trust: The Form 3520 instructions define a U.S. owner as a person treated as owning trust assets under grantor trust rules. Ownership can apply to part of a trust.