Dynastic Foreign Grantor Trust Planning for Foreign Families with U.S. Members

Foreign individuals with U.S. family members have a unique opportunity to grow and transfer wealth to those family members in trust. This is because the U.S. tax system generally does not reach foreign entities owned by foreign individuals, except for such entities’ U.S.-source income and income connected with a U.S. trade or business. Similarly, U.S. estate and gift tax does not reach gifts of non-U.S. situs assets made by a non-U.S. person.

Foreign individuals can capitalize on this opportunity by establishing a foreign grantor trust. During the lifetime of the grantor, a foreign grantrust may offer a U.S. income tax and estate, gift and generation-skipping transfer (“GST” ) tax-free environment in which assets can grow and benefit U.S. family members. For high and ultra-high net worth individuals, a foreign grantor dynasty trust can benefit as many future generations as the trust’s governing law allows.

The issue that foreign grantor dynasty trusts face is the inevitable death of the grantor, whereupon the trust automatically becomes a foreign non-grantor trust. For foreign non-grantor trusts, U.S. income taxes can reach distributions to U.S. beneficiaries of the income that had up to this point grown U.S. income tax-free, and it does so with a harsh and punitive “throwback” tax. The throwback tax can be so confiscatory as to reach the entire amount of the distribution. Consequently, having a plan for dealing with the throwback tax following the grantor’s death is an essential part of establishing the foreign grantor dynasty trust. “Domesticating” the trust by converting it to a domestic non-grantor dynasty trust is a good method of avoiding the throwback tax, but it is not without certain costs, namely, the loss of future growth free from U.S. income taxation.

This article follows the life cycle of the trust during and after the grantor’s life, and it will explain foreign grantor dynasty trusts and their benefits, how to domesticate the non-grantor trust and the dynamics of the throwback tax. This article will also address general principles for good family governance.


A foreign grantor dynasty trust enables growth free from U.S. income tax and distributions to U.S. beneficiaries free from U.S. income tax. This tax advantage continues during the grantor’s lifetime, though the trust itself can continue for as long as its governing law allows, which in several States of the United States can be indefinitely. In order to understand how this works, it is helpful to review some basic trust concepts. This includes the distinction between foreign and domestic trusts, the distinction between grantor and non-grantor trusts, and the purposes of dynasty trusts.

All trusts are either foreign or domestic. A trust is a domestic trust if it passes both the “court test” and the “control test”; conversely, a trust that fails one or both of these tests is a foreign trust. A trust passes the court test if a court within the U.S. is able to exercise primary supervision over the administration of the trust. All trusts permanently sitused and administered within the United States and governed by the laws of a State of the United States pass the court test, so those trusts must fail the control test in order to be classified as foreign. A trust fails the control test if any non-U.S. person has the authority to control a substantial decision of the trust. Under the relevant Treasury Regulations, certain decisions are always considered to be substantial trust decisions. These include decisions regarding whether and when to make trust distributions, the amount of distributions, the selection of a beneficiary, whether to terminate the trust, whether to remove, add, or replace a trustee, investment decisions, and others.

In order to fail the control test and thereby become a foreign trust, a trust must delegate one or more substantial trust decisions to a foreign person. The trust can make this delegation under the trust instrument. What is important to note is that the delegation of a substantial trust decision need not be to a trustee. A trust protector with the power to remove the trustee, or an investment advisor with sole discretion over trust investments, for example, has control over a substantial trust decision. The broad scope of the rule regarding substantial trust decisions makes failing the control test relatively easy, though by the same token it can present a trap for the unwary, as where a trust inadvertently becomes a foreign trust by empowering a foreign person to make a particular decision.

All trusts can also be categorized as either grantor or non-grantor. Whereas non-grantor trusts are separate taxable entities that pay their own income taxes, liability for a grantor trust’s income taxes falls on the grantor. A trust can only be a grantor trust during the life of the grantor; after the grantor dies, a grantor trust becomes a non-grantor trust. For domestic trusts, the rules for determining whether a trust is grantor or non-grantor are numerous and somewhat complicated. In essence, the analysis asks whether the grantor holds certain powers over the trust that should make the grantor be considered the “owner” of the trust. For foreign trusts, the analysis is simpler. A foreign trust is a grantor trust if either 1) it is revocable by the grantor (either alone or with the consent of a related or subordinate person or 2) trust distributions can be made only to the grantor or the grantor’s spouse. As the decision of whether to revoke the trust is a substantial trust decision, it follows that a revocable grantor trust will always be a foreign trust when the grantor is a foreign person. A trust that is a grantor trust by virtue of its permissible beneficiaries, on the other hand, will have to qualify as a foreign trust some other way.

A dynasty trust is simply a trust designed to continue for as long as the governing law of the trust allows. Several States have abolished the common law rule against perpetuities, which limits how long property may be held in trust, and now permit trusts to continue in perpetuity. A trust sitused in such a State is limited in duration only by its terms, or in some cases, its assets. Even a foreign grantor dynasty trust that is subject to the rule against perpetuities can significantly grow and transfer wealth to U.S. beneficiaries free from U.S. income tax and U.S. estate, gift and GST tax over an extended period of time. Dynasty trusts have other benefits as well. For example, dynasty trusts can provide creditor protection for generations of beneficiaries, incentivize values such as charitable giving and professional advancement and offer a structure for long-term management of an asset, such as a closely-held business. In this way, the dynasty trust enables the grantor to leave an enduring legacy.

Photo by ©Zegna
Photo by Zachary Shakked, 2019.

With these concepts in place, we can understand the tax advantages of a foreign grantor dynasty trust.

From a U.S. income tax perspective, a foreign grantor trust is appealing because income of the trust can accumulate free from U.S. income tax, provided the trust is invested correctly. Also, distributions from the trust to a U.S. beneficiary will not cause the U.S. beneficiary to pay U.S. income tax. Whereas U.S. income tax applies to all income, wherever earned, that is generated in a domestic trust, for foreign trusts, only U.S.-source income and income earned in connection with a U.S. trade or business is subject to U.S. income tax. In other words, income from foreign assets held in the foreign trust escapes U.S. income tax. To the extent that the trust has taxable income, as a grantor trust, the grantor is responsible for paying the trust’s taxes. It is for this reason that distributions to U.S. beneficiaries do not cause the U.S. beneficiaries to pay U.S. income tax. This again insulates the trust assets from U.S. income taxes and maximizes the potential for growth during the grantor’s life.

"...as a grantor trust, the grantor is responsible for paying the trust’s taxes. It is for this reason that distributions to U.S. beneficiaries do not cause the U.S. beneficiaries to pay U.S. income tax. This again insulates the trust assets from U.S. income taxes and maximizes the potential for growth during the grantor’s life"

The foreign grantor trust can also shield assets from U.S. “transfer tax,” i.e., estate, gift and GST tax. In a properly structured trust, assets of the trust will not be includible in any beneficiary’s estate, so no U.S. estate tax will be due upon any beneficiary’s death. Though U.S.-situs assets will be subject to U.S. estate tax upon the grantor’s death (there are strategies for blocking this tax, however), the transfer of foreign assets to the foreign trust escapes U.S. transfer tax. Also, because the trust is a dynasty trust, the trust can provide transfer tax relief for as many generations of beneficiaries as the trust’s terms and governing law allows. The foreign grantor dynasty trust minimizes not only U.S. income taxes on the trust’s growth, but also U.S. transfer taxes on the transfer of assets to the trust and within the trust from one generation of beneficiaries to the next.

Finally, upon the death of the grantor, the assets of the trust will receive a “step-up” in basis to the fair market value of the assets as of the grantor’s date of death. Ordinarily, in the United States, an owner’s basis in an asset is the price the owner paid for it. When appreciated property is sold for fair market value, capital gains tax applies to the difference between the sale price and the owner’s basis, that is, on the property’s gain between the time of purchase and sale. The step-up in basis resets the value for taxing appreciation on the asset. When the beneficiary sells the asset for fair market value, capital gains tax will only be imposed on the difference between the sale price and the fair market value of the asset as of the grantor’s date of death.


All grantor trusts become non-grantor trusts upon the death of the grantor. This change carries a significant U.S. income tax consequence, as foreign non-grantor trusts with U.S. beneficiaries are subject to the throwback rules, a U.S. anti-deferral income tax regime. The purpose of the throwback rules are to impose a back tax and an interest charge on income, including realized capital gain, that had escaped U.S. taxation until a distribution. The back tax and interest apply when the accumulated income is distributed to a U.S. beneficiary. In addition, capital gains are taxed as ordinary income under the throwback rules. In this sense, a foreign non-grantor trust that becomes subject to the throwback rules upon the death of the grantor defers the U.S. tax on income rather than avoiding it completely.

Photo by Lerone Pieters, 2019.

Domesticating the trust, that is, turning the trust from a foreign non-grantor trust into a domestic non-grantor trust upon the death of the foreign grantor, prevents the application of the throwback tax regime to the trust. It preserves capital gains tax treatment if capital gain is accumulated in the domestic trust. The tradeoff of domestication is that the trust will be subject to U.S. income tax on all of its future income.

There are three options for domesticating the trust upon the grantor’s death. One option is to establish a domestic trust (a “receptacle trust”) to receive the assets of the current trust, and another is to domesticate the trust itself, by modifying its terms to meet the court test and the control test. Alternatively, the current trust can automatically “flip” to a domestic trust (a “hybrid trust”) if it passes the court and control tests after the grantor’s death. For example, assume that a foreign grantor creates a revocable trust with a U.S. trustee, and all other substantial decisions are controlled by a U.S. person. The trust will pass the court test because of the U.S. trustee, but it will fail the control test for the sole reason that it is revocable by the foreign grantor. When the grantor dies, the trust will no longer have a foreign person with control over a substantial trust decision, so it will pass both the court and control test, making it a domestic trust upon the death of the grantor. As a variation on the hybrid trust, the current trust could split into two (or more) trusts upon the grantor’s death, with one trust becoming a domestic trust for U.S. beneficiaries, and one trust remaining a foreign trust for foreign beneficiaries by reason of a control power in a new foreign person. This would preserve foreign trust status for the foreign beneficiaries, while domesticating the trust for the U.S. beneficiaries in order to avoid the throwback rules.

"As a variation on the hybrid trust, the current trust could split into two (or more) trusts upon the grantor’s death, with one trust becoming a domestic trust for U.S. beneficiaries, and one trust remaining a foreign trust for foreign beneficiaries by reason of a control power in a new foreign person"

Along with offering a U.S. income tax solution, the ensuing domestic non-grantor trust still retains its previous transfer tax advantages if drafted, funded and administered correctly. There will be no estate tax inclusion for any of the beneficiaries, and the trust’s exemption from GST tax will also continue after domestication. The assets of the resulting GST-exempt trust can be distributed to successive generations free of transfer tax, allowing each beneficiary to enjoy the assets to the maximum extent.


As we all know, it is impossible to predict the future and to anticipate every possibility of what could occur within a grantor’s family after the grantor’s death. For example, unfortunately, beneficiaries might have special needs, substance abuse issues or get divorced. Individual trustees may die or become incompetent, and corporate trustees may need to be replaced for a multitude of reasons. Beneficiaries might not possess the qualities or share the values of the grantor, leading to undesirable results. A trust cannot respond specifically to every problem that might arise, and trying to do so would only create further problems when the trust instrument does not authorize a solution to some unanticipated detail. Instead, a trust should empower beneficiaries and fiduciaries to deal with changing circumstances in the best manner possible as they occur. This section describes certain provisions for creating the flexibility necessary for successful long-term trust administration.

With respect to trust distributions to beneficiaries, the trust instrument or a letter of wishes from the grantor can provide guidance for the trustee in considering whether to make a distribution and the amount of the distribution. The trust instrument should allow the trustee to make distributions either outright or in further trust. As an initial matter, the trust instrument can direct the trustee to consider, or not to consider, certain factors when contemplating making a discretionary distribution. These factors can include the beneficiary’s access to resources outside of the trust, the standard of living to which the beneficiary is accustomed, whether the beneficiary has a particular need for the distribution, whether the beneficiary has a substance-abuse or other problem that would make a distribution not in the beneficiary’s best interest and others. An explicit instruction to the trustee to consider such factors gives the trustee guidance as well as a justification for making a decision, which can help avoid conflict with a beneficiary. The ability to make a distribution for the benefit of a beneficiary is important when the beneficiary has difficulty managing money, is incompetent or requires creditor protection. In addition, a beneficiary may wish to receive a distribution in further trust in order to achieve certain tax outcomes as part of the beneficiary’s own estate plan.

Photo by Laura Hornos, 2019.

The trust instrument should have provisions for the removal and replacement of the trustee, and the trust can also use one or more strategies – such as a directed trust structure, in which a trustee is directed as to investments or distributions or by a third party – to control and streamline particular decisions. During or after the grantor’s death, oversight of the trustee, including the power to remove and replace the trustee, can be delegated to a trust protector. Often, the grantor will retain this power during his or her lifetime. Similarly, directed trust structures are mechanisms for removing certain decisions from the control of the trustee and delegating them to another person or entity. This can be particularly useful for making investment decisions involving a complicated asset or closely-held business. Many States now also authorize private trust companies, which are private companies formed to act as a trustee for one or more family trusts. Private trust companies can have several advantages: they offer privacy and control over trust decisions; they can be cost-efficient, as when acting as the trustee for multiple trusts; and they can have their own internal management structures, which promotes flexibility and avoids problems regarding trustee succession.

Finally, grantors can incentivize certain behavior among beneficiaries through the trust instrument. For example, the trust instrument can provide for additional distributions to match a beneficiary’s charitable contributions or salary in a given year. Codifying the grantor’s own values, whether for philanthropy, professional advancement or other desired virtues, by incentivizing beneficiaries to have these qualities in the trust instrument helps to ensure that these values are instilled in successive generations, and it allows the grantor to leave an enduring, non-financial legacy.


For foreign individuals with U.S. family members, a foreign grantor dynasty trust can be a powerful vehicle for growing and transferring wealth during the grantor’s lifetime. Establishing such a trust, though, requires foresight and careful planning for what will happen after the grantor dies. A properly structured trust can preserve the wealth created during the grantor’s life and avoid the reach of the throwback tax. Beyond the tax advantages, good trust drafting can ensure longevity in the administration of the trust and enshrine the grantor’s legacy for future generations.

Kathryn Von Matthiessen

Partner, Katten Muchin Rosenman LLP.

Andrew Toporoff

Associate, Katten Muchin Rosenman LLP.