Cross-Border Trust Structuring for US-Connected Families
Cross-Border Trust Structuring for US Families
Cross-border trust structuring that US families engage in is one of the most technically demanding areas of international private client work, because the US and UK tax systems approach trusts from fundamentally different starting points and often reach opposite conclusions about who owes what tax on the same income. Furthermore, a trust structure that is perfectly efficient for UK tax purposes — reducing IHT exposure, distributing income to lower-rate beneficiaries, and deferring capital gains through holdover relief — may simultaneously create significant US tax problems for any US persons who are settlors, trustees, or beneficiaries connected to that same arrangement. Consequently, families with members who are US citizens or US residents on either side of the Atlantic must approach trust planning with both systems fully in view before any structure is implemented.
Additionally, the consequences of getting cross-border trust planning wrong are not merely theoretical. Specifically, a trust that is treated as a non-grantor foreign trust for US tax purposes but was intended to operate as a straightforward UK family trust can trigger mandatory annual reporting on Form 3520-A, punitive throwback tax on accumulated distributions to US beneficiaries, and 35% excise tax on loans or pledges from the trust to US persons. Moreover, penalties for late or incorrect Form 3520 and 3520-A filings are severe — the greater of $10,000 or 35% of the reportable amount — and apply automatically regardless of whether any tax was actually due. Therefore, understanding how the US treats any proposed trust structure before implementation is not optional for families with a US connection.
How the US and UK Tax Systems Treat Trusts Differently
The US Grantor Trust Rules
US tax law includes a set of provisions known as the grantor trust rules, under which a trust is treated as transparent for income tax purposes if the settlor retains certain powers or interests in the trust property. Specifically, if the settlor retains the power to revoke the trust, the power to control the beneficial enjoyment of the trust assets, or a reversionary interest expected to exceed 5% of the trust corpus at the time of the transfer, the trust will be treated as a grantor trust. All its income will be taxed directly to the settlor as though the trust assets were still in their hands. Furthermore, these rules apply whether the trust is established in the US or in any other jurisdiction, which means a UK discretionary trust established by a US-citizen settlor may be a grantor trust for US purposes even if it is a fully separate legal entity for UK tax purposes.
Consequently, the grantor trust classification can actually be beneficial in some cases, since it means the trust's income is taxed at the individual's rate rather than the trust's rate, and distributions from a grantor trust to US beneficiaries are generally not subject to the throwback tax rules that apply to non-grantor foreign trusts. Moreover, for US gift tax purposes, transfers to a grantor trust in which the settlor remains the grantor are not completed gifts, so the gift and estate tax exemption is not applied at the time of the transfer. This result can be either desirable or undesirable, depending on the family's overall planning objectives.
UK Discretionary Trusts and IHT Charges
In the UK, discretionary trusts are subject to a periodic charge of up to 6% of the trust's relevant property every ten years on the anniversary of the trust's establishment, as well as an exit charge when assets leave the trust and are distributed to beneficiaries or appointed out of the settlement. Furthermore, the relevant property rules apply to trusts settled by UK-domiciled or deemed-domiciled individuals, meaning a US-citizen settlor who has acquired UK deemed domicile through long residence is fully within the relevant property regime, and their trust will be subject to the ten-year charge regardless of whether the trust assets are located in the UK or overseas.
Additionally, for settlors who are not yet UK domiciled or deemed domiciled, a trust settled before the deemed domicile date may enjoy excluded property treatment for UK IHT purposes if its assets consist of non-UK situs assets— that is, assets located outside the United Kingdom. Consequently, the timing of trust establishment relative to the UK deemed domicile date is a critical planning consideration for US citizens who have recently moved to the UK and are planning before the fifteen-year residence threshold is crossed. Therefore, for newly arrived US citizens in the UK, trust planning should be undertaken as a matter of priority in the early years of UK residence. At the same time, the excluded property option remains available.
Key US Reporting Requirements for Cross-Border Trusts
Form 3520 and Form 3520-A
A US person who is the settlor of a foreign trust, receives a distribution from a foreign trust, or is treated as the owner of a foreign trust under the grantor trust rules must file Form 3520 annually to report their transactions with and interests in the trust. Furthermore, the trustee of a foreign trust with a US owner must file Form 3520-A annually, reporting the trust's assets, income, and distributions for the year. Notably, for these rules, a UK trust is almost certainly a "foreign trust" because the test for trust classification under US law — whether a US court has primary supervisory jurisdiction and whether US persons have the authority to control substantial decisions of the trust — is not typically satisfied by a UK settlement governed by English law.
Consequently, US persons who are settlors, trustees, or beneficiaries of UK trusts are almost certainly subject to these reporting requirements, yet, in our experience, many are entirely unaware of them and have never filed Form 3520 or Form 3520-A for years, or even decades, of trust involvement. Additionally, the penalties for failure to file are severe and can accumulate rapidly — a $10,000 minimum penalty per year on Form 3520 alone, with the potential for the 35% excise tax on unreported distributions, can represent a liability many times larger than any tax that was actually owed. Therefore, identifying and regularising missed Form 3520 filings is a priority for any US person connected to a UK trust who has not been filing correctly.
The Throwback Tax on Trust Distributions
Where a non-grantor foreign trust accumulates income that it does not distribute to its beneficiaries in the year it is earned, and subsequently distributes those accumulated earnings to a US beneficiary in a later year, the throwback tax rules impose an additional interest charge on top of the regular income tax. Specifically, the interest charge is calculated by treating the accumulated income as though it had been earned ratably over the accumulation period, taxing it at the highest applicable rate in each of those years, and then charging an interest rate on the resulting notional tax liability from each year of accumulation to the year of distribution. Furthermore, this charge can make distributions from long-established UK discretionary trusts significantly more expensive than the headline income tax rate would suggest, and the calculation requires detailed records of the trust's income history going back to the earliest year of US beneficiary status.
Structures That Work Across Both Systems
The UK Bare Trust for US Beneficiaries
For families seeking a simple structure that avoids the most complex US trust tax issues, a UK bare trust — in which a beneficiary has an immediate, absolute right to the trust assets and income — is treated as transparent for both US and UK tax purposes, since the beneficiary is regarded as the direct owner of the underlying assets. Furthermore, because the beneficiary is treated as directly owning the assets, there is no foreign trust for US reporting purposes, no Form 3520 obligation, and no throwback tax risk on distributions. However, a bare trust does not provide the flexibility of a discretionary trust — the beneficiary's entitlement is fixed and cannot be varied without their consent — so it is only appropriate where that rigidity is acceptable within the family's planning objectives.
Additionally, for US gift and estate tax purposes, a transfer into a bare trust constitutes a completed gift if the settlor retains no powers over the trust assets, meaning the gift tax exemption is applied at the time of the transfer. Therefore, families must weigh the US gift tax cost of establishing a bare trust against the US tax simplicity it provides, taking into account the current elevated exemption and the risk that it will be reduced after 2025. Consequently, establishing a bare trust structure before the sunset may be particularly attractive for families with sufficient exemption to shelter the transfer without incurring the current gift tax.
The QDOT for Transfers to Non-Citizen Spouses
Where a US citizen dies, leaving assets to a spouse who is not a US citizen — a common scenario in UK-based families where one partner has retained non-US citizenship — the unlimited marital deduction does not apply. The full value of the assets passing to the non-citizen spouse may be subject to US estate tax. Furthermore, a qualified domestic trust (QDOT) defers this estate tax until the surviving spouse either takes distributions from the trust or dies, at which point the deferred tax becomes due. Notably, the QDOT must satisfy specific structural requirements — at least one US trustee, restrictions on principal distributions — and must be established by the date the estate tax return is filed.
Moreover, the QDOT can hold UK assets as well as US assets, which makes it a useful vehicle for deferring estate tax on UK residential property, UK investment portfolios, and other UK-situs assets that would otherwise be included in the US taxable estate without the protection of the marital deduction. However, the UK tax treatment of the QDOT must also be considered, since distributions from the QDOT to the UK-resident surviving spouse may be subject to UK income tax on the income element and potentially to IHT on the capital element depending on the surviving spouse's UK domicile status. Accordingly, a QDOT established for a UK-based family must be reviewed by both US and UK advisers simultaneously.
Case Study: US-UK Family Trust Restructuring
Background
Our team was engaged by a US-citizen father and his UK-citizen daughter, both UK residents, in connection with a discretionary trust established by the father in 2008 to hold a portfolio of UK equities and a buy-to-let property. The trust was governed by English law and administered by a UK solicitor as sole trustee. The father had never filed Form 3520 as settlor, and the daughter, who had received two distributions from the trust over the previous five years totaling approximately £180,000, had not reported these distributions on her US return or filed Form 3520 as a US beneficiary receiving distributions from a foreign trust.
Analysis and Resolution
Our analysis confirmed that the trust was a foreign non-grantor trust for US purposes, that the father should have filed Form 3520 annually as settlor since 2008, and that the daughter's distributions were subject to US income tax with a potential throwback interest charge on the accumulated income element. Furthermore, we determined that the trust's accumulated income over the relevant period was approximately £95,000, of which approximately £60,000 had been distributed to the daughter, triggering a throwback calculation. Additionally, we identified that a total of fifteen annual Form 3520 filings had been missed between the two family members. Consequently, we prepared a regularisation package that included all missed filings and calculated the throwback charge, which amounted to approximately $18,400 in additional tax and interest. We coordinated with a UK solicitor to review whether restructuring the trust as a bare trust for the daughter going forward would simplify future US compliance, and the family elected to make that change.
Get in Touch
At US-UK Tax, our specialists provide comprehensive advice on cross-border trust structuring for US families with connections to both the US and UK tax systems. Furthermore, we advise on trust establishment, restructuring, regularisation of missed Form 3520 filings, throwback tax calculations, and ongoing compliance support for trustees and beneficiaries with US reporting obligations. We work closely with UK solicitors and US estate attorneys to ensure that every structure functions efficiently across both systems.
To discuss your trust planning or compliance position, contact our team today. Email hello@us-uktax.com, call 0333-8807974, or visit https://www.us-uktax.com/contact/ to book a confidential consultation.
Conclusion
Cross-border trust structuring undertaken by US families requires expertise in both US and UK tax law, and structures optimized for one system without regard to the other almost always create unexpected problems. Furthermore, the US reporting obligations connected to foreign trusts — Form 3520, Form 3520-A, and the throwback tax on accumulated distributions — are among the most heavily penalized areas of US international tax compliance, making early identification and regularisation of missed filings a financial priority. Moreover, with the potential sunset of the elevated gift and estate tax exemption after 2025, the current period offers a narrow window to implement trust structures that utilize the current higher exemption before it may be reduced. Consequently, families with US connections on both sides of the Atlantic should act promptly and engage specialist cross-border advisers rather than relying on advisers with experience in only one jurisdiction.
Contact US-UK Tax today at hello@us-uktax.com or call 0333-8807974 for a confidential review of your trust position.
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