What Makes a Trust Foreign: the Court and Control Tests
Whether a trust is "foreign" is where everything starts, because the entire tax and reporting picture flows from that one answer. US law calls a trust domestic only if it passes both of two tests, and if it fails either one, the trust is foreign.
The first is the court test: a court inside the United States has to be able to exercise primary supervision over how the trust is administered. The second is the control test: one or more US persons must control all the substantial decisions of the trust (things like whether and when to distribute, how to invest, and whether to remove a trustee), with no one else able to veto them. Pass both and the trust is domestic. Fail either and it is foreign.
In plain terms, an ordinary Israeli family trust (an Israeli trustee, administered in Israel, under Israeli court supervision) is foreign on both counts, and there is usually nothing subtle about it. The classification only gets close when a US co-trustee or a US "trust protector" holds real power over distributions or removal. And it can change: a trust can flip from foreign to domestic, or the reverse, after a trustee change, and the flip itself can be a taxable event. So we re-test after any change in who runs the trust.
Grantor or Non-Grantor: Who the US Actually Taxes
Once a trust is foreign, the next question is who the US taxes on its income, and there are two very different answers.
A foreign grantor trust is one the tax code still treats as owned by a single person, so the trust is ignored and its income is taxed straight to that owner. Two ways lead there when a US person is in the picture. The big one is the rule for a US person who funds a foreign trust that has a US beneficiary: that person is treated as the owner and taxed on the trust's worldwide income as if it were their own (the next section is all about it). The other runs the opposite direction. When a non-resident (someone who is not a US taxpayer) sets up the trust, the US generally does not treat them as owner, which is exactly why a trust funded by, say, grandparents in Israel can pass its corpus (the property held in the trust) to US heirs without US income tax landing on the trust's earnings. That flips, though, if the trust is revocable by the non-resident, or if only the non-resident or their spouse can receive money during their life.
A foreign non-grantor trust is the other posture: no one is treated as the owner, so the trust is its own separate taxpayer. Here a US beneficiary is taxed on distributions of current-year income, and, if the trust let income pile up before paying it out, on that accumulated income through the throwback rule below. This is the most common situation for a US child or grandchild receiving money from an established foreign family trust.
Funding a Foreign Trust: the Section 679 Trap for Olim
Here is the trap that catches olim most often. If you are a US person and you transfer property to a foreign trust that has, or even could have, a US beneficiary, the law treats you as the owner of that trust and taxes you on its entire worldwide income, year after year, as if the trust did not exist. The presumption that the trust has a US beneficiary is strong: it applies unless you can show that no US person can benefit, even on a remote, someday, contingent basis. Because most family trusts are written with a broad, discretionary class of beneficiaries that could include a US person, the safe assumption for an oleh funding an Israeli trust is that this rule applies.
Then there is the timing trap that surprises people. If you transfer property to a foreign trust while you are still a non-resident, and you become a US person within five years of that transfer, the law treats the transfer as if you made it on the day you became a US person. So a trust you funded before you ever moved can be pulled into US tax once you immigrate. This five-year pre-immigration lookback is exactly why the highest-value moment to get advice is before you fund anything and before you move, not after.
If instead of funding a foreign trust you receive money from one, a different and equally costly rule applies. That is the throwback rule.
The Throwback Rule: Why Accumulated Income Is So Costly
If you are a US beneficiary of a foreign non-grantor trust, the quiet wealth-destroyer is the throwback rule (a tax on income the trust piled up in earlier years and only later paid out to you). Here is how it works, in plain terms.
Income the trust earns and pays out in the same year is taxed to you that year, as normal income. But income the trust keeps instead of distributing becomes "accumulated" income, and it sits there. When the trust later hands you more than one year's worth of income, the excess is treated as thrown back to the years it was originally earned. On top of recomputing the tax for those old years, the law adds a non-deductible compound interest charge that runs from those years all the way to the year you finally received the money. Because foreign trusts often accumulate for decades, that interest can approach, and sometimes exceed, the value of the accumulated part of the distribution itself.
Two more stings. The thrown-back income is taxed at ordinary income rates no matter what the trust actually earned, so the lower capital-gains rates are lost, and there is no step-up in basis. And if the trust's records are too thin to reconstruct year by year (common with older family trusts), the beneficiary may have to use a fallback called the default method: the part of a distribution that tops 125% of the average of the prior three years' distributions is treated as accumulated income, taxed at a flat rate with a blunt interest charge. It is often unfavorable, but sometimes it is the only workable path.
The single most valuable move here is prevention. If the family can get the trustee to distribute each year's income within the year (or within the first 65 days of the next year), it never becomes accumulated income, and there is no throwback exposure at all. A trust that distributes currently is clean. Decades of accumulated income is what turns a distribution radioactive.
Connected to a foreign trust, or inheriting through one?
A free 30-minute consult screens whether the trust is foreign, whether you are its transferor, owner, or beneficiary, and which forms and taxes you actually face.
Book your free consultThe Forms That Cause the Penalties: 3520 and 3520-A
The penalties in this area come from the forms, not the tax, because they are fixed-dollar or percentage amounts that apply whether or not you owed a cent of tax. Two forms do most of the work.
Form 3520 is the catch-all, filed by the US person (not the trust) with their tax return. It covers four situations: you transferred property to a foreign trust; you are treated as the owner of one; you received a distribution from one (this is where the throwback computation gets reported); and, separately, you received a large gift or inheritance from a foreign person. That last category has its own thresholds: more than $100,000 in a year from a foreign individual or a foreign estate (a fixed figure that has never been indexed for inflation), or more than $20,573 for 2026 from a foreign corporation or partnership. Missing a foreign-gift report carries a penalty of 5% per month, up to 25% of the gift. Missing a transfer or distribution report runs to the greater of $10,000 or 35% of the amount involved.
Form 3520-A is the foreign grantor trust's own annual return, due before the individual return each year. The practical problem: a foreign trustee in Israel is not going to file a US tax form. When that happens, the US owner has to file a substitute 3520-A himself, attached to his own return, or eat the penalty, which is the greater of $10,000 or 5% of the value of the trust portion he is treated as owning. This substitute filing is the single most missed step for an oleh who is treated as a foreign trust's owner.
Two more forms coordinate with these. The FBAR (a separate report of foreign financial accounts topping $10,000 combined) can reach a trust's accounts when you are its owner, or a beneficiary entitled to more than half of its income or assets. Form 8938 reports foreign assets on your tax return, and while an asset properly reported on a 3520 or 3520-A does not also have to be detailed on the 8938, the FBAR is always its own separate filing. Some Israeli pension and savings vehicles (kupat gemel, keren hishtalmut) are themselves analyzed as foreign trusts for this purpose. A narrow IRS exemption can spare certain retirement vehicles from the 3520 forms, but it often does not fit, and that pension analysis is its own separate exercise we handle apart from the family-trust question.
One current bright spot: since late 2024 the IRS has stopped automatically assessing the foreign-gift penalty on a late Form 3520 and now reviews a reasonable-cause explanation first, after a finding that about two-thirds of those penalties were later abated. So if you are behind, the move is to file the delinquent forms with a strong reasonable-cause statement, not to hope no one notices. Do not lean on the argument, floated in some cases, that the IRS lacks authority to assess these penalties; the courts have narrowed it, and it is not a plan. For the deeper look at that $100,000 foreign-gift rule and the 3520 penalty, see our page on the Form 3520 foreign-gift penalty.
Inheritances and Distributions Routed Through a Foreign Trust
A lot of this surfaces the moment a US person inherits from abroad, so it is worth separating the calm case from the costly one.
The calm case: a grandparent in Israel leaves you money or property outright. A foreign gift or inheritance is not US-taxable income, no matter how large. If it tops $100,000 in the year, you report it on Form 3520 for information only, and the only real risk is the penalty for not reporting it, up to 25% of the amount. That is a filing problem, not a tax bill.
The costly case: the same inheritance comes to you through a foreign trust or a foreign estate rather than outright, and it carries years of accumulated trust income along with it. Now the throwback rule rides in on top of the reporting, and a distribution you thought was a tax-free inheritance can carry a real tax plus that compounding interest charge. The difference between the two cases is not the amount you receive. It is the plumbing the money travels through. That is why, on any inbound inheritance with a foreign trust anywhere in the chain, the distribution needs to be looked at before it is spent, not after.
The Israeli-Trust Picture and the Tax Mismatch
For olim there is one more layer, and it is the reason these matters need two advisors instead of one. Israel taxes trusts under its own regime, and it generally taxes the trust itself as the taxpayer, sorting trusts by where the settlor and the beneficiaries live. A trust set up by a foreign settlor can become taxable in Israel once even one beneficiary is an Israeli resident, sometimes at a rate in the range of 25% on the Israeli portion. Those are Israeli-law questions we flag and route to Israeli counsel, not ones we opine on.
The friction is the mismatch. A new immigrant's ten-year Israeli tax holiday on foreign-source income can shelter the Israeli side of a trust and do nothing at all for the US side, because a US citizen who makes aliyah still owes US tax on worldwide income. Worse, Israel may treat the trust as the taxpayer while the US treats you, as the funder or the beneficiary, as the taxpayer. When the two countries tax different people, the foreign tax credit that is supposed to prevent double taxation may not line up, and you can end up taxed on both sides. Untangling that is genuinely dual-country work, which is why we co-counsel Israeli and US tax advisors rather than guess at half of it.
How We Work, and When We Co-Counsel
Foreign-trust work runs from a simple reporting cleanup to a decades-old accumulation problem, so we are clear about where our role sits. The screening that tells you whether the trust is foreign, whether you are its transferor, owner, or beneficiary, and which forms you owe; the estate and Florida planning side; and the strategy for coming into compliance are handled here. The throwback computation, the specialized federal forms (Form 3520 and the substitute Form 3520-A), and the modeling of a decades-old accumulation we co-counsel with an international tax advisor, so you get the right depth. Anything turning on Israeli law goes to Israeli counsel.
Where this meets our Florida practice is the estate. When a US family in Florida stands to inherit through a foreign trust, or an oleh wants a plan that does not accidentally hand the next generation a throwback problem, that is estate planning, and it is what we do. Most of it runs remotely, by phone and video, which suits clients who are out of state or out of the country, including the many Americans living in Israel. The first and most valuable step is the screen, because it decides everything after it. See the full international and cross-border guide →
Frequently Asked Questions
Do I Owe US Tax on a Foreign Trust My Family Set Up?
Not on the trust existing. You owe US tax on distributions of income you actually receive, and if the trust accumulated income in earlier years before paying you, on that accumulated income through the throwback rule, which adds a compounding interest charge. You almost certainly have to file Form 3520 for any distribution. And if you are entitled to more than half of the trust or can sign on its accounts, the FBAR and Form 8938 may apply too. The practical goal is to receive current-year income, not accumulated income, whenever the family can influence the trustee.
What Is a Foreign Grantor Trust?
It is a foreign trust the tax code still treats as owned by one person, so the trust is ignored and its income is taxed straight to that owner. Two paths lead there. A US person who funds a foreign trust that has a US beneficiary is treated as the owner and taxed on the trust's worldwide income. Separately, when a non-resident sets up the trust, the US usually does not treat them as owner, which can let the trust's property pass to US heirs without US income tax on its earnings, unless the trust is revocable or only the non-resident or their spouse can benefit during life.
I Am Making Aliyah and Want a Trust for My US-Citizen Kids. Any US Problem?
Yes. Because the trust would have US beneficiaries, the law treats you as its owner and taxes you on its worldwide income as if it were your own, and you must file Form 3520 and a substitute Form 3520-A every year, since the Israeli trustee will not file US forms. There is also a timing trap: if you fund the trust before you become a US person and then immigrate within five years, a lookback pulls it in anyway. Coordinate the timing, and whether to use a foreign trust at all, with counsel before you fund it.
My Grandmother in Israel Left Me $250,000 Outright. Do I Report It?
It is not taxable income, but because it is more than $100,000 from a foreign individual or estate, you report it on Form 3520 for information only. Miss that report and the penalty runs up to 25% of the gift. If instead the money had come to you through a foreign trust rather than outright, we would also run the throwback analysis on any income the trust had accumulated before paying you, which can turn a tax-free inheritance into a real tax bill.
What Is the Throwback Rule and Why Is It So Expensive?
The throwback rule taxes income a foreign trust piled up in past years and only later paid out to you. On top of recomputing the tax for those old years, the law adds a non-deductible compound interest charge that runs from the year the income was earned to the year you received it. On a trust that accumulated for decades, that interest can approach or even exceed the accumulated part of the distribution. The income is also taxed at ordinary rates with no step-up in basis. The fix is prevention: a trust that distributes its income each year never creates the problem.
I Forgot to File Form 3520 for a Few Years. How Bad Is It?
It is fixable, but act now. Since late 2024 the IRS no longer automatically assesses the late foreign-gift penalty and reviews a reasonable-cause explanation first, after finding that about two-thirds of those penalties were later abated. So we file the delinquent forms with a strong reasonable-cause statement, and consider the streamlined or delinquent-information-return procedures depending on whether any tax was owed. Do not rely on the argument that the IRS cannot assess these penalties; the courts have narrowed it, and it is not a plan.
Are My Israeli Pension and Savings Accounts Foreign Trusts?
Some are analyzed that way. Vehicles like kupat gemel and keren hishtalmut can be treated as foreign trusts, which raises the Form 3520 and 3520-A questions, and the underlying funds can raise a separate foreign-mutual-fund issue. A narrow IRS exemption can spare certain tax-favored retirement vehicles from the 3520 forms, but it frequently does not fit, especially a training or education fund you can withdraw before retirement. Do not assume any Israeli pension is automatically exempt. That pension analysis is its own exercise, which we handle apart from the family-trust question.
Do You Handle This In-House or Refer It Out?
Both, depending on the facts. The screening, the reporting map, the compliance strategy, and the estate and Florida planning side are handled here. The throwback computation, the specialized federal forms (Form 3520 and the substitute Form 3520-A), and the modeling of a decades-old accumulation we co-counsel with an international tax advisor so you get the right depth. Anything turning on Israeli law goes to Israeli counsel. We tell you up front which pieces your matter needs before you commit to anything.
Common Situations
The US grandchild who is only a beneficiary. An Israeli couple set up a family trust years ago, and their US-citizen granddaughter is one of several beneficiaries. She owes no US tax on the trust existing. If the trustee distributes each year's income to her within the year, she reports the distributions on Form 3520 and owes ordinary tax on that income, with no throwback. If instead the trust accumulated income for a decade and then paid her a lump sum, the throwback tax and interest charge can take a large bite, and we model the default method against the exact method to find the smaller number. Either way, the counsel to the family is the same: distribute currently.
The oleh funding a trust for US kids. An American planning aliyah wants to set up an Israeli trust for children who are US citizens. Because the trust would have US beneficiaries, he would be treated as its owner and taxed on its worldwide income, with an annual Form 3520 and a substitute Form 3520-A that he, not the Israeli trustee, has to file. And if he funds it before the move and immigrates within five years, the five-year lookback pulls it in anyway. The right time to decide whether to use a foreign trust at all is before funding, which is exactly when he came in.
The inbound bequest through a foreign estate. A Florida family learns that a relative in Israel left them an inheritance, paid through a foreign estate rather than outright. The first question is not how much, it is how it traveled: an outright bequest over $100,000 is a Form 3520 reporting item and nothing more, but a distribution carrying years of the estate's accumulated income drags the throwback rule along with it. We look at the distribution before it is spent, map the 3520, and coordinate the compute with an international tax advisor.
Sources of Law
- Foreign vs. domestic classification (the court and control tests): 26 U.S.C. §7701(a)(30)(E), (a)(31)(B); Treas. Reg. §301.7701-7. law.cornell.edu
- Grantor-trust attribution: 26 U.S.C. §§671 to 679 (especially §679, transfers to a foreign trust with a US beneficiary, and §679(a)(4), the five-year pre-immigration lookback); §672(f) (limit on treating a foreign person as owner); Treas. Reg. §§1.679-1, 1.679-2, 1.679-4. law.cornell.edu
- Throwback rule, accumulation distributions, and the interest charge: 26 U.S.C. §§665 to 668 (§668 non-deductible compound interest charge on distributions from a foreign trust); §663(b) (the 65-day rule); the default method per the Instructions for Form 3520. law.cornell.edu
- Outbound transfers and loans: 26 U.S.C. §684 (gain on transfers to a foreign trust, with the grantor-trust and §679 exception); §643(i) (loans and use of trust property treated as distributions).
- Reporting and penalties: 26 U.S.C. §6048 (Forms 3520 and 3520-A); §6677 (greater of $10,000 or 35% for transfer or distribution failures, or 5% of value owned); §6039F (large foreign gifts, the $100,000 fixed threshold and the inflation-indexed corporate/partnership threshold of $20,573 for 2026, 5% per month up to 25%). FBAR: 31 U.S.C. §5314 and FinCEN Form 114. Form 8938: 26 U.S.C. §6038D. irs.gov
- Tax-favored foreign trust exemption from Forms 3520 and 3520-A (the pension screen): Rev. Proc. 2020-17.
- Penalty-assessment authority (do not bank the "cannot assess" theory): Farhy v. Commissioner, D.C. Cir. (2024); Mukhi v. Commissioner, 163 T.C. No. 8 (2024). (retrieved 2026-07-24)
Updated on July 24, 2026. Reviewed by Kevin D. Klagge, Esq., Fla. Bar No. 99502. Attorney Kevin Klagge represents families, businesses, and international clients in estate planning and international law, with a focus on Florida legal tools. He litigates estate and business issues in court. This article is general information about US law, not legal or tax advice, and does not create an attorney-client relationship. Foreign-trust taxation is specialized; the throwback computation and Forms 3520 and 3520-A are co-counseled with an international tax advisor, and Israeli or other foreign-country tax is handled by foreign counsel. Federal figures are adjusted periodically and may change. Your result depends on your specific facts.