Trust Planning for Non-U.S. Parents with U.S. Children

What the IRS’s own ruling tells us about structuring a Foreign Grantor Trust — and why getting this wrong is a multi-million-dollar mistake

You’ve spent a lifetime building wealth. Your children live in the United States. And somewhere along the way, someone told you that transferring that wealth to them — cleanly, efficiently, without losing a significant portion to U.S. taxes — is complicated.

They weren’t wrong. But complicated doesn’t mean impossible. It means you need the right structure — and an attorney who understands exactly how it works.

This article explains one of the most powerful tools available to non-U.S. families with American children: the Foreign Grantor Trust combined with a U.S. Dynasty Trust.

We’ll show you what it does, what problems it solves, and what the IRS itself has confirmed about how it works.

What Problem Does This Solve?

If you are a non-U.S. citizen living outside the United States, and your children or grandchildren are American residents, you face a specific set of challenges that most estate planning attorneys are not equipped to handle:

• How do you support your children financially without them paying U.S. income tax on the money they receive?
• How do you protect your assets — including U.S. real estate — from U.S. estate tax when you pass away?
• How do you ensure your wealth reaches the next generation, and the generation after that, without being eroded by taxes at every step?
• How do you buy a home or invest in the U.S. real estate market without inadvertently creating a massive estate tax exposure?

These are real questions that real families face — whether you live in Dubai, São Paulo, Singapore, London, or anywhere else in the world.

And the answer, for many high-net-worth families, is a structure called a Foreign Grantor Trust.

What Is a Foreign Grantor Trust, in Plain English?

A Foreign Grantor Trust is a trust you set up outside the United States — typically in a jurisdiction like the Cayman Islands, BVI, or Liechtenstein — that holds your assets and distributes money to your U.S. children.

Here is the key advantage: because you are a non-U.S. person who retains certain control over the trust, the IRS does not tax the trust’s income.

And when the trust sends money to your children in America, those payments are treated as gifts from you — a non-U.S. person. Which means your children pay no U.S. income tax on those distributions.

Think of it this way. A father living in Hong Kong has $20 million in investments. His two adult children live in New York.

Every year, the trust earns income and distributes $500,000 to each child.

Under a properly structured Foreign Grantor Trust, neither child pays U.S. income tax on that money.

The IRS confirmed this treatment in Private Letter Ruling 200338015, one of the few times the agency has put its reasoning on paper for this type of structure.

What About U.S. Real Estate? Can That Go Into the Trust?

This is the question we hear most often — and the answer surprises most clients. Yes.

U.S. real estate can be held inside a Foreign Grantor Trust. But only if the structure is set up correctly.

Here is the problem with holding U.S. real estate directly.

As a non-U.S. resident, your U.S. estate tax exemption is only $60,000 — compared to over $15 million for U.S. citizens.

That means if you own a $5 million apartment in Manhattan directly, your family could face a $2 million estate tax bill when you die. That is the cost of not planning.

The solution is a foreign blocker corporation.

Instead of the trust owning the U.S. property directly, the trust owns a foreign company (typically a BVI or Cayman entity), which owns the U.S. property.

Because the trust holds foreign company shares — not U.S. real estate directly — those shares are classified as non-U.S. assets for estate tax purposes.

The result: the same Manhattan apartment, owned through the right structure, with zero U.S. estate tax exposure.

IRS PLR 200338015 confirms when gain recognition under Section 684 does and does not apply, clarifying that these rules are limited to transfers to foreign trusts rather than domestications of foreign trusts to U.S. status.

The IRS’s own guidance in PLR 200338015 confirms that when a Foreign Grantor Trust is properly converted to a U.S. Dynasty Trust, the transfer itself “is not treated as a transfer to a foreign trust” — meaning no capital gains tax is triggered, even on assets that have appreciated significantly over the years.

The Big Risk Nobody Talks About: What Happens When You Die?

Here is where most families — and unfortunately, many advisors — get this wrong.

A Foreign Grantor Trust is powerful during your lifetime. But without planning for what happens after your death, it can create a serious tax problem for your children.

When you pass away, the Foreign Grantor Trust loses its special tax status.

If your children then receive distributions from that trust, they can face what is called the throwback tax — a harsh rule that taxes accumulated trust income at the highest rate, plus interest charges for every year that income sat in the trust. Effective tax rates on those distributions can exceed 70%.

The solution is to plan for this before it happens — which is where the second piece of the structure comes in.

The Annual Distribution Rule: Why You Must Distribute Income Every Year

Here is one of the most important practical rules in Foreign Grantor Trust planning — and one that many clients only discover after it is too late to act on it.

Every year that the Foreign Grantor Trust earns income — from investments, rental property, interest, or any other source — that income must be distributed to your U.S. children during your lifetime.

Not most of it. Not eventually. Every year, consistently, before you die.

The reason is straightforward. Any income that the trust earns but does not distribute becomes what the IRS calls Undistributed Net Income (UNI).

UNI sits inside the trust, quietly accumulating. During your lifetime, while you are the foreign grantor, this is not a problem — the trust pays no U.S. tax on it.

But the moment you die and the trust transitions to your children, the IRS activates the throwback rules under IRC §§ 665–668.

At that point, every dollar of UNI that was ever left inside the trust becomes taxable — and the tax bill can be severe.

What the Throwback Tax Actually Costs: A Simple Example

Imagine the trust earns $500,000 per year for 20 years. Each year, rather than distributing that income to your children, the trustee reinvests it inside the trust.

At the end of 20 years, the trust has accumulated $10 million in UNI sitting quietly inside it.

You pass away. The trust transitions to your children. Over the following years, your children begin receiving distributions from the Dynasty Trust. When those distributions are traced back to the $10 million of UNI, the throwback rules apply:

• Accumulated UNI over 20 years ($500K/year, not distributed): $10,000,000
• Federal income tax on UNI at highest marginal rate (37%): $3,700,000
• IRS interest charge on accumulated income (approx., 20 years): $2,200,000+
• Total tax cost on $10M of accumulated income: ~$5,900,000+ (59%+ effective rate)

If distributed annually instead — treated as tax-free gifts: $0 tax

The interest charge is particularly punishing.

Unlike regular income tax, which applies once, the IRS calculates interest for each individual year the income sat undistributed in the trust.

Income accumulated in year one carries twenty years of interest charges. Income accumulated in year ten carries ten years.

The longer the trust runs without distributing, the worse the eventual tax bill becomes. It compounds in the wrong direction.

Why Annual Distributions Are Tax-Free to Your Children

This is the part that surprises most clients.

When the Foreign Grantor Trust distributes income to your U.S. children during your lifetime, the IRS treats those distributions as gifts from you — a non-U.S. person.

Gifts from non-U.S. persons to U.S. recipients are not subject to U.S. income tax. Your children pay zero U.S. income tax on those distributions — regardless of the amount.

They do have one obligation: each U.S. child must report every distribution on IRS Form 3520 by April 15 of the following year.

This is a reporting requirement, not a tax return. They are disclosing the gift — not paying tax on it.

Missing this filing, however, triggers a penalty equal to the greater of $10,000 or 35% of the entire distribution amount. On a $500,000 distribution, that is a $175,000 penalty for a missed form.

The Complete Solution: Combining the Foreign Grantor Trust with a U.S. Dynasty Trust

The Foreign Grantor Trust is designed from day one with instructions that, upon your death, all assets transfer automatically into a South Dakota Dynasty Trust — a U.S. trust that holds and grows the family’s wealth for your children, grandchildren, and every generation that follows.

Why South Dakota? Because it is the best trust jurisdiction in the United States. No state income tax. No rule against perpetuities — meaning the trust can last forever.

Some of the strongest creditor protection laws in the country. And a legal framework purpose-built for exactly this kind of multi-generational structure.

When the transition from the Foreign Grantor Trust to the Dynasty Trust is properly structured, the IRS has confirmed in PLR 200338015 that:

• There is no capital gains tax on the transfer of assets
• There is no gift tax triggered by the conversion
• There is no generation-skipping transfer tax on distributions to grandchildren — ever — if the original trust was funded correctly

That last point deserves emphasis.

For U.S. families, transferring wealth to grandchildren requires careful use of the generation-skipping transfer tax exemption — currently about $15 million per person.

For a non-U.S. family that funds the trust correctly from the beginning, the IRS confirmed in PLR 200338015 that “the GST tax does not apply to distributions from and terminations of the Trust” at all.

Not because of an exemption allocation — but because the tax never applies. That is a fundamentally different — and far more powerful — outcome.

One Warning the IRS’s Own Ruling Teaches Us

PLR 200338015 also contains a cautionary lesson buried in its facts.

The grantor in that ruling moved to the United States within five years of setting up the trust.

That single fact triggered a provision of U.S. tax law that immediately treated him as the owner of the trust for U.S. income tax purposes — with full tax obligations from the date of his move.

The IRS confirmed this applied in his case.

The lesson: if you are a non-U.S. client who thinks you might ever move to the United States — for any reason — your trust structure must include a plan for that scenario.

Getting it wrong after the fact is far more expensive than building the contingency in from the start.

Is This Structure Right for Your Family?

A Foreign Grantor Trust combined with a U.S. Dynasty Trust is not for everyone. It is most valuable when:

• You are a non-U.S. citizen or resident with significant assets outside the United States
• You have children, grandchildren, or other beneficiaries who live in the U.S.
• You own or want to own U.S. real estate, U.S. investments, or U.S. business interests
• You want to protect your wealth from creditors, lawsuits, and divorce proceedings
• You want your family’s wealth to last for multiple generations — not just your children’s lifetimes
• You are considering moving to the United States and want to plan before you arrive

If any of these describe your situation, the structure is worth exploring with an attorney who specializes in exactly this area.

The compliance requirements are real — your U.S. children will need to file annual reports with the IRS, and missing a filing can trigger significant penalties.

But with the right team in place, this structure runs smoothly and delivers exactly what it promises.

Work With Max Dilendorf

Max Dilendorf is an attorney at Dilendorf Law Firm, based in New York.

He represents domestic and international high-net-worth families and individuals across a broad range of matters, including cross-border tax planning, foreign trust structuring, U.S. Dynasty Trust formation, pre-immigration planning, and asset protection strategies.

Max also represents clients navigating complex cybersecurity incidents and advises individuals and families on building asset protection plans designed for the digital age — including the protection and proper structuring of cryptocurrency and other digital assets.

Whether your family is based abroad, you are planning a move to the United States, or you are managing wealth across multiple jurisdictions and asset classes — Max and his team can help you build a structure that works.

To schedule a consultation, reach out directly:

W: dilendorf.com | P: 212.457.9797 | E: max@dilendorf.com

Quick Answers to Common Questions

Can a non-US parent set up a trust for US children without paying US gift tax?

Yes — if the trust holds non-U.S. assets. The IRS confirmed in PLR 200338015 that a non-resident alien who transfers non-U.S. situs assets to a foreign trust does not trigger U.S. gift tax. The assets are outside the U.S. gift tax system entirely.

What happens to the trust when the foreign parent dies?

Without planning, the trust loses its favorable tax status and the children can face severe throwback taxes. With proper planning, the assets pour over into a U.S. Dynasty Trust with no capital gains tax, no gift tax, and no generation-skipping transfer tax — as confirmed by IRS PLR 200338015.

Can I buy real estate in New York or Miami through a Foreign Grantor Trust?

Yes — through a foreign blocker corporation that sits between the trust and the U.S. property. This structure converts a U.S. situs asset into non-U.S. situs stock, eliminating estate tax exposure for non-U.S. residents.

Do my children have to pay tax on money they receive from the trust?

No — during the grantor’s lifetime, distributions from a Foreign Grantor Trust to U.S. beneficiaries are treated as gifts from a foreign person. U.S. beneficiaries report them on Form 3520 but pay no U.S. income tax on the amounts received.

Resources

Foreign Grantor Trust — Governing Statutes

26 U.S.C. § 671 — Grantor Treated as Substantial Owner

https://www.law.cornell.edu/uscode/text/26/671

26 U.S.C. § 672(f) — Special Rule for Foreign Grantors

https://www.law.cornell.edu/uscode/text/26/672

26 U.S.C. § 675(4) — Power to Substitute Assets (Swap Power)

https://www.law.cornell.edu/uscode/text/26/675

26 U.S.C. § 676 — Power to Revoke Trust

https://www.law.cornell.edu/uscode/text/26/676

26 U.S.C. § 679 — Foreign Trusts with U.S. Beneficiaries; Five-Year Residency Rule

https://www.law.cornell.edu/uscode/text/26/679

26 U.S.C. § 684 — Recognition of Gain on Transfers to Foreign Trusts

https://www.law.cornell.edu/uscode/text/26/684

26 U.S.C. § 7701(a)(30)(E) — Definition of Foreign Trust

https://www.law.cornell.edu/uscode/text/26/7701

Estate and Gift Tax — Non-U.S. Resident Rules

26 U.S.C. § 2103 — Nonresident Alien Estate Tax: Definition of Gross Estate

https://www.law.cornell.edu/uscode/text/26/2103

26 U.S.C. § 2104 — Property Situated in the United States (Situs Rules)

https://www.law.cornell.edu/uscode/text/26/2104

26 U.S.C. § 2501 — Gift Tax: Transfers by Nonresident Aliens

https://www.law.cornell.edu/uscode/text/26/2501

Generation-Skipping Transfer Tax

26 U.S.C. §§ 2601–2663 — Generation-Skipping Transfer Tax

https://www.law.cornell.edu/uscode/text/26/2601

Treas. Reg. § 26.2663-2(b)(2) — GST Tax Applied to NRA Transferors

https://www.law.cornell.edu/cfr/text/26/26.2663-2

Compliance and Reporting

26 U.S.C. § 6048 — Reporting Requirements for Foreign Trusts

https://www.law.cornell.edu/uscode/text/26/6048

26 U.S.C. § 6677 — Penalties for Failure to File Foreign Trust Returns

https://www.law.cornell.edu/uscode/text/26/6677

26 U.S.C. § 6501(c)(8) — Unlimited Statute of Limitations for Foreign Trust Non-Filers

https://www.law.cornell.edu/uscode/text/26/6501

IRS Form 3520 — Annual Return to Report Transactions with Foreign Trusts

https://www.irs.gov/forms-pubs/about-form-3520

IRS Form 3520-A — Annual Information Return of Foreign Trust with a U.S. Owner

https://www.irs.gov/forms-pubs/about-form-3520-a

IRS Guidance — Foreign Account Tax Compliance Act (FATCA / Form 8938)

https://www.irs.gov/businesses/corporations/foreign-account-tax-compliance-act-fatca

IRS Guidance — Foreign Bank Account Reporting (FBAR / FinCEN 114)

https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar

Treasury Regulations

Treas. Reg. § 1.684-2(e) — Termination of Grantor Trust Status; Deemed Transfer

https://www.law.cornell.edu/cfr/text/26/1.684-2

Treas. Reg. § 20.2104-1 — Property Situated in the United States (NRA Estate Tax)

https://www.law.cornell.edu/cfr/text/26/20.2104-1

Treas. Reg. § 25.2511-1 — Transfers of Intangible Property by Nonresident Aliens

https://www.law.cornell.edu/cfr/text/26/25.2511-1

IRS Administrative Guidance and Private Letter Ruling

IRS Private Letter Ruling 200338015 (PLR-105942-03) — Domestication of Foreign Trust; No § 684 Gain, No Gift Tax, No GST Tax

https://www.irs.gov/pub/irs-wd/0338015.pdf

IRS Overview — Foreign Trusts with U.S. Owners or Beneficiaries

https://www.irs.gov/businesses/international-businesses/foreign-trust-reporting-requirements-and-tax-consequences

Revenue Ruling 2023-2 — Basis Step-Up Denied for Irrevocable Grantor Trust Assets Not in Gross Estate

https://www.irs.gov/pub/irs-drop/rr-23-02.pdf

South Dakota Dynasty Trust

S.D. Codified Laws § 10-43-91 — No South Dakota State Income Tax on Trusts

https://sdlegislature.gov/Statutes/10-43-91

S.D. Codified Laws § 55-1-20 — No Rule Against Perpetuities (Perpetual Dynasty Trusts)

https://sdlegislature.gov/Statutes/55-1-20

S.D. Codified Laws §§ 55-16 — Domestic Asset Protection Trust (DAPT) Statute

https://sdlegislature.gov/Statutes/55-16-1

S.D. Codified Laws § 55-1B — South Dakota Directed Trust Statute

https://sdlegislature.gov/Statutes/55-1B-1

This article is for general informational and educational purposes only. It does not constitute legal or tax advice and does not create an attorney-client relationship. Tax laws change, and individual circumstances vary. Please consult qualified U.S. international tax and estate planning counsel before taking any action.