US citizenship-based taxation: Navigating expatriation for trust beneficiaries of foreign non-grantor trusts

Covered expatriates, defined by net worth, tax liability, and tax compliance criteria, are subject to a mark-to-market (MTM) regime. This requires recognising gains on worldwide assets as if sold the day before expatriation. However, interests in foreign non-grantor trusts are treated differently. Distributions to covered expatriates are subject to a flat 30% withholding tax on the taxable portion.

Trustees must apply this tax withholding and calculate the taxable portion using standard foreign non-grantor trust rules. This creates ongoing US tax obligations for both trustees and the covered expatriate beneficiaries. In the year of expatriation, the US taxpayer must file Form 8854 to certify tax compliance and report assets, including trust interests and distributions. (Note: It is not clear how the US can enforce withholding obligations on non-US trusts.)

Covered expatriate US beneficiaries must choose between waiving reduced withholding rights (through a double tax treaty), or electing to treat their entire trust interest as received before expatriation, potentially triggering early taxation. Annual Form 8854 filings are required to report distributions or confirm none were received. Trustees must inform beneficiaries of any distributions to support accurate reporting.

Additionally, the US beneficiary must file a final Form 1040 (personal tax return) together with a Form 3520 (trust reporting). Trustees must provide a Foreign Non-Grantor Trust Beneficiary Statement to help beneficiaries complete their Form 3520 for distribution reporting.

Planning ahead is essential: trustees should evaluate trust interests, understand exit tax implications, and review reporting duties if they have a US beneficiary considering expatriation. Reach out to a US tax advisor specialising in US tax reporting related to non-US trusts and expatriation options to assist in navigating the complexities of expatriation.

Expatriation may ease the burden of US taxation, but for foreign trust beneficiaries, it introduces new complexities. Understanding the tax regime, withholding rules, and reporting requirements are key to managing this transition effectively.

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Tas Meghani is a Tax Director and Head of Trusts & Estates, with 20 years’ US/UK tax experience and heads the USTAXFS global trust tax team. She focuses on US and international tax associated with non-US trusts and US beneficiaries, advising on complex US tax compliance and information reporting.