Most Americans know what a “trust” is. A “trust” typically refers to an entity created and governed under the state law in which it was set up, and it can be created in many ways. “Grantor trust” is a concept used in the U.S. Tax Code to describe any trust the grantor (or founder) retains control over or benefits from the income or assets in the trust. Whether a trust is categorized as a “grantor trust” significantly impacts how the grantor, the trust, and the beneficiary are taxed. Considering that in the case of a grantor trust, the grantor technically has the power to transfer the assets in the trust back to himself or herself, the grantor trust is not recognized as a separate taxable entity. As a result, the trust income is taxed to the grantor, regardless of whether or not the income has been distributed to a third party.

The trust instrument can be powerful and material when determining whether a trust is a grantor trust. According to the IRS, the power to control or benefit from the trust income can be demonstrated through the grantor’s power to add or change the beneficiary of the trust, the power to vote or to direct vote of the stock held by the trust, the power to control the investment of the trust, the ability to modify, revoke or even terminate the trust agreement, the power to designate and select trustee, etc. Therefore, according to the IRS, all “revocable trusts” are, by definition, grantor trusts. An Irrevocable trust can also be treated as a grantor trust depending on the trust instrument and the governing law.

The rules are more complicated when it comes to foreign trusts. Once it has been determined that a foreign entity should be taxed as a trust for U.S. tax purposes, one should answer the question of whether the foreign trust will be treated as a foreign grantor trust or a foreign non-grantor trust. Generally speaking, a foreign trust that has, or is deemed as having U.S. beneficiaries will normally be treated as a grantor trust on the of assets in proportion to the value of assets transferred into the trust by a U.S. person. Given the complexity of the rules, it is entirely possible for a U.S. person to unknowingly become a grantor of a foreign grantor trust and fails to include the trust income in his taxable income or file information returns. However, IRS offers several programs, including the Streamlined Filing Procedure, for eligible taxpayers to correct their mistakes. If you believe that you have a foreign trust taxation issue, contact us today.