Australian Family Trusts and the US Grantor Trust Trap
Australian discretionary trusts are a cornerstone of domestic tax planning, asset protection, and intergenerational wealth strategies. However, when a family has US connections, whether through US citizenship, green card status, or US tax residency under the substantial presence test, these same structures can become highly inefficient, costly, and risky from a US tax perspective. In many cases, the very tax benefits Australians seek by using discretionary trusts are neutralised or reversed entirely once the US foreign trust regime applies.
This article explores why Australian trusts so often fall foul of US tax rules, the compliance and penalty risks involved, and the practical implications for Australians and US persons on both sides of the Pacific.
Why the US Is Suspicious of Foreign Trusts
The US foreign trust regime reflects its historical origins. In the 1980s and 1990s, promoters widely marketed foreign trusts as offshore tax avoidance vehicles. Often using secrecy jurisdictions and limited disclosure. In response, Congress created an extremely prescriptive and punitive regime to capture all foreign-controlled trust arrangements and their grantors, no matter where they are established.
As a result, the US treats most non‑US trusts as potential tax avoidance tools by default, even where they exist in high‑tax, transparent countries like Australia.
Australian Discretionary Trusts and the Grantor Trust Problem
Under Australian tax law, discretionary trusts are flexible vehicles allowing trustees to distribute income among beneficiaries each year. Under US tax law, that same flexibility is often fatal.
Where a US person settles or funds an Australian trust, controls it, for example as trustee or appointor, or retains certain powers or interests, the trust is commonly classified as a foreign grantor trust under US tax rules.
The US grantor trust regime intends to look through foreign structures and tax the individual who effectively controls or benefits from the trust, rather than allowing them to defer or shift income offshore.
What does this mean in practice?
If the US treats an Australian trust as a foreign grantor trust, it taxes all trust income to the grantor, regardless of who actually receives distributions. The US ignores Australian income streaming, and timing mismatches often arise, creating double taxation with limited ability to claim foreign tax credits.
In many cases, this treatment effectively undoes the Australian tax advantages that originally motivated the use of the trust.
Other Australian Structures That Can Be Caught as Foreign Trusts
While Australian discretionary trusts are the most commonly impacted structures, the US foreign trust regime does not limit its reach to them alone.
The US rules deliberately cast a wide net and apply to any foreign arrangement that functions like a trust and that a US person controls or funds. As a result, they can also capture other Australian structures, including certain superannuation arrangements.
In some cases, the IRS treats Australian superannuation as a foreign trust rather than a pension. Particularly where a US taxpayer has control, influence, or identifiable ownership interests. In those situations, the IRS analyses superannuation under the same foreign trust and grantor trust provisions that apply to discretionary trusts.
This approach means superannuation can fall within the same look-through rules, reporting obligations, and compliance risks as other foreign trusts, even though Australian law treats it as a compulsory retirement vehicle.
The US Foreign Trust Reporting Regime, Forms 3520 and 3520‑A
The US imposes one of the world’s most comprehensive international reporting regimes for trusts.
Key forms include Form 3520, the annual return to report transactions with foreign trusts and receipt of certain foreign gifts. Also Form 3520‑A, the annual information return of foreign trust with a US owner. US taxpayers must file these forms even if they ultimately owe no US tax. This is simply because they own, control, or transact with a foreign trust.
Penalties for non‑compliance
Failure to file, or filing incorrectly, can trigger automatic penalties, including a minimum USD $10,000, up to 35 percent of contributions or distributions, or 5 percent of total trust assets for grantor trust reporting failures.
These penalties can apply even when no tax is due.
While historically enforcement was inconsistent, IRS scrutiny has increased significantly since 2018, and advisers have observed a marked rise in Form 3520 penalty assessments in recent years.
Recent Developments: New Foreign Trust Regulations
In 2024, the US Treasury and IRS released extensive proposed regulations. They addressed foreign trusts, gifts, loans, and the use of trust property. These proposals reinforce the underlying policy intent of the foreign trust regime. That is, to prevent the use of foreign entities to defer, disguise, or avoid US taxation by individuals who effectively control those entities.
The regulations expand reporting obligations and strengthen the treatment of loans, use of trust property, and arrangements that resemble gifts in substance.
What This Means in Practice
US taxpayers living in Australia
US citizens, green card holders, and individuals treated as US tax residents should seek specialist US tax advice. That is, before using Australian discretionary trusts or assuming that Australian structures fall outside the US tax net.
Any perceived Australian tax savings must be weighed against full US taxation of trust income, loss of income streaming benefits, ongoing compliance costs, and significant penalty exposure. In many cases, alternative structures or simpler ownership arrangements may be more efficient.
Australians relocating to the US
Australians moving to the US with existing trusts or other foreign structures should plan well before becoming US tax residents. This includes reviewing how those entities may be classified under US tax law. Additionally, whether restructuring is required to avoid unintended tax outcomes.
Restructuring after US residency begins can be far more expensive and complex.
Australians giving or lending money to US persons
Gifts and loans to US taxpayers can inadvertently trigger US reporting obligations or recharacterisation under foreign trust rules. Professional advice is essential to ensure transactions are structured correctly and do not create unnecessary compliance issues for the recipient.
Final Thoughts on Australian Family Trusts and the US Grantor Trust Trap
Australian trusts, and in some cases superannuation and other foreign structures, remain powerful domestic tools. However, once US tax law applies, the regime specifically targets foreign-controlled trusts and taxes their grantors directly.
With the IRS continuing to refine and expand its foreign trust framework, early advice and careful planning are essential for families with US ties.
Contact Us
If managing your financial affairs across borders is starting to feel overwhelming, you’re definitely not alone. It’s a complex space, and having the right support can make all the difference. At Atlas Wealth Group, we specialise in supporting Australian expats with cross-border tax planning, superannuation, mortgages and wealth management. Contact us to arrange a consultation with a qualified adviser who specialises in Australian expat financial planning to get personalised guidance tailored to your circumstances.
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Disclaimer: This article is intended for informational purposes only and does not constitute legal or financial advice. Individuals should consult licensed professionals when seeking guidance regarding their financial circumstances.