Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use Cross-Border Trusts
Transcript
- Lucas: So there's a phrase that keeps coming up in family office circles this year: cross-border trusts. And it's not just exotic planning for the ultra-mobile. A friend of mine who advises Swiss residents with American ties told me about a client who almost got hit with a seven-figure tax bill because of a trust that was structured in the wrong jurisdiction. Luna: Wrong jurisdiction meaning the trust was sitting in a state with high taxes, or wrong country entirely? Lucas: Both can bite. But the case I'm thinking of was a foreign trust that the IRS decided was actually a domestic trust for U.S. tax purposes. That reclassification triggered a bunch of reporting obligations nobody had planned for. The client was a Swiss resident, but he had U.S. citizenship, so he was still on the hook for U.S. taxes on worldwide income. Luna: And the trust was set up in Switzerland, but the IRS said it was domestic? How does that happen? Lucas: It comes down to the definition in the tax code. A trust is foreign unless a U.S. court can exercise primary supervision over it and one or more U.S. persons have authority to control all substantial decisions. If the trust document gives a U.S. trustee too much power, or if the situs ends up being a U.S. state because of where the assets are held, the IRS can argue it's domestic. In this case, the family office had appointed a U.S.-based co-trustee to handle the children's tuition payments, and that shifted the balance. Luna: So one seemingly small appointment turned a foreign trust into a domestic one for tax purposes. That's a steep price for a convenience. Lucas: Exactly. And it's not just about the tax rate. Once it's classified as domestic, the trust is subject to the full U.S. fiduciary income tax regime, including the throwback rules for accumulated income. That's where the seven-figure number came from. The trust had been retaining earnings for years, planning to distribute them after the grantor's death. Under foreign trust rules, that's fine. Under domestic trust rules, you owe a penalty tax on the accumulated income. Luna: That's brutal. So the fix would have been to keep the trust clearly foreign, maybe by having a foreign trust company as the sole trustee and making sure all administrative decisions happen outside the U.S. Lucas: Right. And that's what they ended up doing, but only after a lot of back and forth with the IRS and a significant legal bill. The takeaway for our listeners: if you're a U.S. person with assets abroad, or a non-U.S. person with U.S. connections, the situs of your trust is a decision that should be made with a specialist who understands both the local law and the U.S. tax code. Luna: Speaking of specialists, I've been reading about a rise in 'trust migration'—moving an existing trust from one jurisdiction to another. Is that a common solution when you realize you've got a problem? Lucas: It's becoming more common. Trust migration can be a legitimate fix, but it's tricky. You can't just change the situs on paper. The trust has to actually move—the trustee, the administration, the assets. And if the IRS thinks you did it just to dodge taxes, they can challenge it. There have been cases where a migration was ignored for tax purposes, and the trust was treated as if it never left the old jurisdiction. Luna: So it's not a silver bullet. But I guess it's better than the alternative of just tearing up the trust and starting over. Lucas: For sure. Tearing up a trust can trigger capital gains taxes, gift taxes, and a whole mess of unintended consequence. Migration is cleaner if done right. But it's not something you DIY. You need legal opinions from both the old and new jurisdictions, and you have to be transparent with the IRS about the purpose. Luna: And what about the reporting side? I've heard horror stories about the forms you have to file for foreign trusts. Lucas: Oh, absolutely. Form 3520 and Form 3520-A are notorious. If you're a U.S. person who receives a distribution from a foreign trust, you file 3520. If you're the grantor of a foreign trust that's treated as a grantor trust for U.S. tax purposes, the trustee files 3520-A. And the penalties for late or incorrect filing start at ten thousand dollars, but they can balloon to thirty-five percent of the gross value of the distribution if you miss the deadline entirely. Luna: Yikes. So it's not just about getting the tax right, it's about getting the paperwork right, too. And these forms are dense. I remember reading that the instructions for 3520 are over fifty pages long. Lucas: Yeah, it's a compliance nightmare. That's why so many family offices now have a dedicated international tax team, or at least a law firm that specializes in this. But here's something interesting: the IRS has been cracking down on cross-border trusts lately. There were several cases in 2025 where the courts sided with the IRS on the classification issue, and that's pushed more families to be proactive. Luna: Proactive how? Getting a pre-approval from the IRS before setting up a trust? Lucas: That's possible, but it's expensive and slow. More often, they're doing a thorough analysis upfront, looking at the grantor's residency, the beneficiaries' citizenship, the location of assets, and the trustee's powers. They're running scenarios to see how the trust would be classified under different fact patterns. It's like a stress test for your estate plan. Luna: So the real lesson is that cross-border trusts aren't something you set and forget. They need ongoing monitoring, especially as family members move or change their citizenship. Lucas: Exactly. And that's what separates a good family office from a mediocre one. The good ones have a process for reviewing the trust structure every few years, or when a major life event happens—a marriage, a divorce, a move to another country, a new business venture abroad. Because the tax landscape is always shifting, and what was a perfect structure in 2020 might be a liability in 2026. Luna: And speaking of shifting landscapes, we're recording this in August 2026, and I've noticed that more and more private banks are offering trust services across borders. Is that a trend you're seeing too? Lucas: Definitely. Banks like UBS and Credit Suisse have been expanding their fiduciary services for years, but now even mid-sized regional banks are partnering with trust companies in places like Singapore, Switzerland, and the Cayman Islands. The demand is coming from ultra-wealthy families who want asset protection and tax efficiency, but also from a desire for privacy and flexibility. Luna: But with that demand, there's also more scrutiny. The OECD's automatic exchange of information has made it harder to hide assets in offshore trusts, and the U.S. has its own FATCA regime. So it's not like you can just park everything in a trust and forget it. Lucas: Right. Transparency is the new normal. That doesn't mean cross-border trusts are useless—they're still great for legitimate estate planning and asset protection—but they have to be set up with full disclosure and compliance in mind. The days of using a foreign trust to hide money from the IRS are long gone, if they ever existed. Luna: So what's the one thing you'd want a listener to take away from today's episode? If they're considering a cross-border trust, what's the first question they should ask? Lucas: I think it's this: 'What happens if the IRS reclassifies my trust?' Because that's the nightmare scenario. If you're prepared for that, you've done your homework. And the second question is, 'Who's responsible for filing all the forms, and what's their track record?' Because in the end, a trust is only as good as its administration. Luna: That's a solid note to end on. Thanks for breaking this down, Lucas. I feel like I can finally explain to my uncle why his cross-border trust needs a full-time compliance team.