Trusts can be created, also known as settled, for a variety of reasons and often form part of family estate planning in the US and UK.
Despite this, the tax rules, legal considerations, implications of investing, distribution timing and even just the terms used can be challenging to navigate. This is especially true where there is more than one jurisdiction to consider.
It is therefore important to have a team of professionals that can help you plan effectively cross-border and to keep compliant with any trust tax filings.
What is a trust?
In simple terms, a trust is a legally binding agreement between three distinct parties:
- Settlor – Also known as the grantor in the US, is the person that settles assets into the trust for the benefit of a beneficiary.
- Trustee – The trustee is the person, or sometimes a professional trust company, that is responsible for administering the trust in line with the purpose of the trust. This purpose and directions are typically detailed in the trust deed, or a separate letter of wishes provided at time of settlement.
- Beneficiary – The beneficiary is the person that is to benefit from the trust, whether from the outset or at some point in the future – for example at a pre-determined date or age. Beneficiaries are usually children or grandchildren of the grantor where a trust is used for generational transfers of wealth.
Key US Terms
Below are some of the key terms that you may come across if you are a US taxpayer involved in trust planning:
- Revocable trust – This type of trust is where the trust agreement can legally be revoked by the grantor. The trust does not pay its own taxes and instead the grantor continues to report income/gains on their own US tax filings. These types of trust are commonly also known as grantor trusts.
- Irrevocable trust – This type of trust is where the trust agreement cannot be revoked by the grantor. The trust is a separate taxable entity in the US and is liable to US taxes at the rates applicable to trusts. These types of trust can commonly also be known as non-grantor trusts.
- Foreign vs US trust – A grantor or non-grantor trust is classified as US or Foreign under US tax law by the court and control tests. These tests should always be considered with your tax advisors or lawyers as this distinction will determine how the trust is taxed and the IRS (Internal Revenue Service) filings required.
How might a trust be ‘US connected’?
A trust will likely have US tax exposure and reporting obligations if either the grantor, trustee, or beneficiary are considered US taxpayers. This can include a US citizen, Green Card holder or just an individual that is considered substantially present (based on a specific day count tests) in the US.
US Tax Filings
Some of the US tax filings that can be required if you are a US taxpaying grantor, trustee, or beneficiary of a trust:
Form 3520 – Annual Return to Report Transactions with Foreign Trusts
Form 3520(A) – Annual Information Return of Foreign Trust with US owner.
Form 1040 – US Individual Income Tax Return
Form 1041 – US Income Tax Return for Estates and Trusts.
The deadlines to file these forms vary and so do the penalties for non-compliance. These penalties can be high and settling these can in some cases significantly reduce the value of a trust.
You should always consult a US tax professional to ensure US taxes are paid at the correct level and to ensure the appropriate forms are timely filed.
Please note that this article is focused only on the basics for US purposes. If you are a grantor, trustee, or beneficiary living in the UK then there will also likely be UK taxes and filings to consider.