Setting Up a Trust in the United States: A Guide for Non-U.S. Families

Many families outside the United States now look to an American trust to protect what they have built. The idea is sound. The details decide whether it works, and the details are set in the first few decisions.

What a U.S. trust does

A trust is a legal arrangement. You transfer assets to a trustee, who holds and manages them for the people you name. Those people are the beneficiaries.

Families use a U.S. trust for three reasons. It can shield assets from future claims, it can pass wealth to children on your terms, and several states refuse to honor foreign forced-heirship rules.

South Dakota law provides that a trust governed by its law is not void or defective because it “avoids or defeats any right, claim, or interest conferred by the law of a foreign country upon any person by reason of a personal relationship to the trustor or by way of heirship rights” [1].

Decision one: domestic or foreign

This is the decision most families do not know they are making.

For U.S. tax purposes a trust is domestic only if “a court within the United States is able to exercise primary supervision over the administration of the trust” and “one or more United States persons have the authority to control all substantial decisions of the trust” [2]. Any trust that fails either test is foreign, even if a Delaware bank is the trustee.

The second test catches many family plans. “Control” means making all substantial decisions “with no other person having the power to veto any of the substantial decisions,” and the rule looks at “all persons who have authority to make a substantial decision of the trust, not only the trust fiduciaries” [2].

Substantial decisions include “whether and when to distribute income or corpus,” “the selection of a beneficiary,” and “whether to remove, add, or replace a trustee” [2].

So if a trusted adviser at home can block distributions or replace the trustee, the trust is foreign. That is not always bad. But it must be chosen, not discovered later.

Why does it matter? A domestic trust is a U.S. taxpayer on its worldwide income. A foreign trust is taxed only on U.S. income, but every U.S. person who receives a distribution must report it on Form 3520, including “uncompensated use of property of a foreign trust,” and the penalty for an unreported distribution starts at the greater of $10,000 or 35 percent of its value [3] [4].

If one of your children may move to America, that child’s position should determine the choice.

One more rule surprises non-U.S. founders. The provisions that treat a founder as the owner of trust income apply to a foreign founder only where the result is that income is “currently taken into account” by a U.S. citizen, resident or domestic corporation [5]. Treatment that works for American founders often does not work for you.

Decision two: which state

Three states are usually on the list. Each allows what most of the world does not: a trust you create, from which you may still receive discretionary benefits, that your future creditors cannot reach. The protection comes from each state’s statute, and the statutes differ.

Delaware requires a “qualified trustee,” meaning a Delaware resident or a company authorized under Delaware law, and a creditor may attack the transfer only under the fraudulent transfer law, with the burden “to prove the matter by clear and convincing evidence” on the creditor [6].

A creditor whose claim arose after the transfer must sue within four years. Exceptions exist for alimony, child support and pre-existing injury claims, but Delaware states those exceptions do not apply to “any claim for forced heirship, legitime or elective share” [6].

South Dakota has the shortest clock. A creditor who existed before the transfer generally has two years; a later creditor has two years from the transfer, and the burden is again clear and convincing evidence [7]. Support and property-division debts owed to a spouse or children at the time of transfer are excepted, but not forced-heirship claims [8].

South Dakota also lets you name a trust protector with powers to “remove and appoint a trustee,” veto or direct distributions, and change the trust’s governing law [9]. Remember the control test: a foreign protector with those powers makes the trust foreign.

Wyoming’s statute states that a creditor of the founder “has only those rights with respect to the qualified trust property” the statute provides, and must prove “by clear and convincing evidence that the transfer of property to the trust was a fraudulent transfer.” It adds that no creditor “shall have any claim or cause of action for forced heirship or legitime” against the trust property [10]. Wyoming’s trust must declare itself a qualified spendthrift trust and adopt Wyoming law [10].

State income tax is simpler. South Dakota “does not impose a state income tax” [11], and a memorandum to the Wyoming Legislature confirms that “Wyoming has no state income tax of any kind, whether on individuals, businesses, or trusts” [12]. No state statute, however, changes the federal rules below.

Decision three: what you keep

The state statutes let you keep more than the federal tax rules reward. Delaware, for example, lists powers a founder may hold without making the trust revocable, including a veto over distributions and a power to substitute assets of equal value [6]. Those provisions decide creditor protection, not U.S. estate tax.

For a person who is neither a U.S. citizen nor domiciled there, estate tax reaches U.S.-situated property, and the IRS lists U.S. real estate and shares of U.S. companies among the assets covered. The filing threshold is $60,000, and it is not indexed [13].

Property comes back into your estate if you kept “the possession or enjoyment of, or the right to the income from” it, or the right “to designate the persons who shall possess or enjoy” it [14]. A reserved right to use a Miami apartment is exactly that.

Gift tax is narrower. For a non-U.S. donor it applies only to real and tangible property situated in the United States; intangible property such as shares and bank deposits is not taxed [15].

The practical lesson is to fund the trust with cash from abroad and let the trust buy the American assets. Deeding an apartment you already own is a taxable gift.

Decision four: when you fund it

Every one of these statutes protects a transfer only if it was not made to defeat creditors. If you have signed personal guarantees, the timing and record of funding matter. A transfer made while solvent, before any default or demand, with full disclosure to the trustee and nothing hidden, is the one the statutes were written for.

Keep practical control out of your hands. A founder who continues to direct every decision, through a friendly protector or informal instructions, weakens both the tax position and the creditor protection. The trustee must be real.

Decision five: the children

Children’s interests should be discretionary. In South Dakota a spendthrift clause restrains “voluntary or involuntary alienation of a beneficial interest by a beneficiary to the maximum extent provided by law,” and the trustee “may directly pay any expense on behalf of such beneficiary” rather than handing over money [1]. That is the structure that holds up when a child divorces or is sued.

A child who becomes a U.S. resident changes the picture. If the trust is foreign, that child’s distributions are reportable and accumulated income can be taxed harshly. If the trust is domestic, the trust itself pays U.S. tax.

Decide which burden the family prefers before the child moves.

The order that works

1. Choose domestic or foreign first. Then assign protector and adviser powers to fit that choice.
2. Choose the state for its creditor rules, trustee requirements and costs, and appoint a qualified trustee there.
3. Give up what the tax rules require: no right to use, no right to income, no power to choose who benefits.
4. Fund with foreign cash before the trust buys U.S. assets, while solvent and documented.
5. Set up the reporting for the trust and any U.S. family member before the first distribution.

This article is for general informational purposes only and does not constitute legal or tax advice. Outcomes depend on the facts of each matter and no result is guaranteed. Reading it does not create an attorney-client relationship with Dilendorf Law Firm. Prior results do not guarantee a similar outcome. Attorney Advertising.