Setting Up a Trust in the USA: The Alternative to a Family Foundation

The family foundation, a familiar vehicle for managing wealth in Europe, simply does not exist in the English-speaking world or the USA. Foundations there are set up for charitable purposes (e.g. the "Bill & Melinda Gates Foundation"), but for private estate and wealth planning, the trust is used across the board.

1A trust is not a legal entity

First things first: unlike a foundation, a trust is not a legal entity. A trust has no legal personality of its own. A trust is a fiduciary arrangement between a grantor and a trustee for the benefit of a beneficiary.

1.1A brief history

The concept of the trust has been around for more than 2000 years and dates back to the Roman Empire. Before heading off to distant campaigns, soldiers handed their property and assets to friends to make sure their families were provided for. During the occupation of the British Isles, trusts became common practice there.

The trust arrived on American soil with the settlers. At first, trusts in America were seen as something only the rich could afford. But because they are flexible and effective, trusts were used more and more to pass on wealth safely. Structured properly, a trust can deliver significant tax advantages for grantors and beneficiaries alike. That is why trusts are no longer set up only by the wealthy, but also by middle-class families and individuals.

2Types of trusts in America

Trusts come in many types and structures. In the USA, so-called living trusts are the most common.

2.1Revocable Trust (also: Revocable Living Trust)

With a revocable trust, the grantor has the right to amend, revoke or terminate the trust at their own discretion during their lifetime. For tax purposes, the assets held in a revocable trust are still treated as the grantor's personal assets. When the grantor dies, all assets are subject to both federal and state estate tax.

When the grantor of a revocable trust dies, the trust becomes irrevocable. The trust can also be structured to split into separate irrevocable trusts for the benefit of the beneficiaries.

2.2Irrevocable Trusts

Unlike a revocable trust, an irrevocable trust cannot be amended, modified or terminated once it has been created. As soon as a grantor transfers property into the trust, it cannot be taken back.

An irrevocable trust can only be changed by the trustee or the beneficiaries under certain conditions. One example is when the estate plan is reviewed and amended by a trust protector. When assets of the trust are sold, the trust ends.

There are two different kinds of irrevocable trusts: living irrevocable trusts and testamentary irrevocable trusts.

2.3Testamentary Trusts

Testamentary trusts are created in connection with the grantor's last will and testament. Assets and property belong to the grantor only until death; after that, they pass to the trust. During the grantor's lifetime, the trust can be amended or revoked at any time. Once the grantor dies, it becomes an irrevocable trust.

Because a testamentary trust only comes into being after the grantor's death, it cannot be used to avoid probate. Once the testamentary trust takes effect, a trustee manages the funds held in it and stays in that role until the trust expires. The trust can be set up to expire at a specific point (e.g. when the beneficiary reaches a certain age).

2.4Discretionary Trust

With a discretionary trust, the grantor appoints a trustee who decides when and how much income or property is distributed to a beneficiary. The grantor usually gives the trustee general guidelines for managing the trust but leaves the details to the trustee.

In a fully discretionary trust, the trustee has more freedom to decide how the assets are managed and when and how much is distributed to the beneficiaries. This type of trust is extremely flexible and cost-effective, which is why families use it so often.

2.5Incentive Trust

With an incentive trust, the grantor sets guidelines and limits for distributions based on the beneficiaries' behavior or status. This type of trust ties distributions to specific conditions, and payouts are made only once the beneficiaries meet them.

Typical conditions include graduating from college, attending a particular school, getting married, joining the family business or reaching a certain income level.

2.6Family Trust

Family trusts are set up mainly to pool assets and reduce tax exposure when passing them on to family members. They are usually created by an individual or a couple as a way to distribute their wealth to beneficiaries.

The purpose of a family trust is to transfer assets into the trust so that the trustee legally owns no personal assets but still keeps control through the trust. The trustee then distributes the assets to the heirs at regular intervals, whether or not the grantor is still alive.

Family trusts can be set up either during your lifetime with a declaration of trust or after death under the terms laid down in the will.

3How are trusts taxed in the USA?

How a trust is taxed depends on the type of trust. Income distributed to the beneficiaries is deductible for the trust. In that case, the beneficiary pays the income tax on that amount, not the trust itself.

The amount distributed to the beneficiary comes first from the current year's income and then from accumulated capital. This is usually the original contribution plus later contributions and income in excess of the amount distributed. Capital gains on this amount can be taxed either to the trust or to the beneficiary. All amounts distributed to or for the benefit of the beneficiary are taxable to them up to the trust's distribution deduction.

An irrevocable trust that has discretion over distributions and retains its income pays tax of $3,851 plus 37% of the excess over $16,000 (tax year 2026). In other words, trusts hit the top rate at very low levels of retained income.

4US trusts for nonresidents

Nonresident aliens (NRAs) and others without unlimited US tax liability pay US income tax only on their US-source income. Nonresidents are subject to gift, estate and generation-skipping transfer tax only on US-situs assets.

Foreign trusts fall into two groups: grantor and non-grantor trusts. Income from a foreign grantor trust is generally taxed to the grantor, not to the trust itself or its beneficiaries. Income from a foreign non-grantor trust, by contrast, is generally taxed when it is distributed to US beneficiaries, unless the trust earns and retains US-source or effectively connected income.

A trust is treated as a grantor trust if:

• the grantor (the person who creates the trust) keeps the right to transfer trust property into their own name without anyone else's consent
• amounts from the trust can be distributed only to the grantor or their spouse during the grantor's lifetime 

A grantor trust is disregarded for both income tax and estate tax purposes. A non-grantor trust, by contrast, is taxed as a separate taxpayer.

4.1Standby dynasty trust for NRAs in the USA

The Stand-By Dynasty Trust is a strategy for foreign nationals with US beneficiaries who have set up offshore trusts in offshore jurisdictions. It reduces the income tax filing requirements for the US beneficiaries and limits the unfavorable US income tax rules on distributions of accumulated income.

After the grantor's death, the foreign trust "pours" the offshore trust assets for the benefit of the US beneficiaries into an existing (nominally funded) domestic dynasty trust. This trust can also benefit foreign beneficiaries.

5Which states are most popular for setting up trusts for non-residents?

There is no single trust law in the US, because every state has its own. In 2000, the National Conference of Commissioners on Uniform State Laws (NCUSL) drafted a uniform trust law: the Uniform Trust Code. Its aim is to provide precise, comprehensive and easily accessible guidance on questions of trust law. To date, 36 states and the District of Columbia have adopted the Uniform Trust Code. 

For international clients, Alaska, Delaware, Nevada, New Hampshire, South Dakota and Wyoming are especially attractive, because they offer flexibility and control, tax savings, asset protection and privacy. Of these, only Wyoming and New Hampshire have adopted the Uniform Trust Code so far. These states offer a modern trust jurisdiction without levying an income tax.

5.1Tax advantages of trusts in Wyoming

Residents of Wyoming pay no state income tax. This advantage also applies to non-residents accumulating income in an irrevocable trust. On top of that, there is no corporate income tax, no gift or estate tax, no capital gains tax and no tax on mineral holdings.

In addition, trust agreements in Wyoming do not have to be registered or recorded. Wyoming law allows a trust to last 1000 years, so families can benefit from stronger asset protection and lower taxes across generations.

Wyoming also offers advantages for corporate trustees. All corporate trustees are licensed by state banking commissions, and while it is often possible to form unlicensed private trust companies (PTCs), these are normally subject to strict rules and capitalization requirements. Wyoming is the exception: here you can set up unregulated, unregistered PTCs at comparatively low cost.

5.2Tax advantages of trusts in South Dakota

South Dakota also levies no income tax on trusts. There is no capital gains tax and no tax on dividends and interest. Nor are there any state LLC or LLP taxes, ad valorem taxes, or city or local taxes.

For families, South Dakota offers one more advantage: it has no generation-skipping transfer tax. The US generation-skipping transfer tax applies to direct gifts and to transfers in trust to unrelated persons more than 37.5 years younger than the donor, and to related persons more than one generation younger than the donor.

In most cases, GST tax on trusts only applies when no gift or estate tax is incurred on the transfer at each generation level.

A South Dakota quiet trust can offer further benefits. With this type of trust, the grantor can restrict information about the trust, and even its existence, from a beneficiary.

5.3Tax advantages of trusts in Nevada

Nevada has no state income tax. A Nevada trust is generally subject only to federal income tax. Having no state income tax makes a real difference to the long-term growth potential of your wealth.

Under Nevada law, assets can be held in trust for up to 365 years, protecting the transfer of wealth from one generation to the next free of tax. California law, by contrast, allows trust protection for only 21 years after the death of the last beneficiary alive when the trust was created, or 90 years after the trust was created.

Nevada is one of the few states that allow directed trusts, where certain trust decisions can be made by advisors appointed in advance. With a directed trust, investment, distribution and other decisions can be placed in the hands of a family member, a trusted advisor or a long-standing business partner, while the trustee handles administrative and other decisions.

6Disadvantages of US trusts

One of the main drawbacks of trusts in America is the cost of setting them up, as this usually requires legal counsel. If, at the time of death, the individual still holds assets in their own name that are not part of the trust, and there is no will, those remaining assets are distributed under the state's rules of intestacy.

This means setting up a trust and a will can be expensive. Administering the trust can add further costs. Unless the trust deed says otherwise, the trustee is usually entitled to reasonable compensation for the time spent managing the trust, even if the trustee is a private individual. So if you want to set up a trust, budget not only for legal counsel at the start but also for ongoing administration and the trustee's compensation.

Further drawbacks arise because the grantor is no longer the actual owner of the assets once they are in a trust. Banks and financial institutions may impose extra hurdles and paperwork when a loan or other financing is requested using trust assets as collateral.

A trust can also be inconvenient for beneficiaries. Instead of receiving property directly, they may have to make repeated requests through the trustee. A trustee can refuse requests, which can create tension between the beneficiaries and the trustee.

You can find more on the tax framework on our page on US estate tax for non-US citizens and in our Tax hub.

In short

• A trust is not a legal entity but a fiduciary arrangement between grantor, trustee and beneficiary. In the US, it fills the role of a family foundation.
• There are revocable and irrevocable, testamentary, discretionary, incentive and family trusts.
• Distributed income is taxed to the beneficiary. Income retained in an irrevocable trust hits the top rate of 37% at low amounts.
• Non-residents pay income tax only on US income, and gift and estate tax only on US assets. Popular states are Alaska, Delaware, Nevada, New Hampshire, South Dakota and Wyoming.
• Trusts cost money to set up and run, and the grantor no longer owns the assets.

How we help you

• US Tax ConsultationYour US tax question, answered by people who know both sides.
• Your US Tax ReturnForm 1040 or 1040-NR, handled in English.
• Withholding taxW-8 forms, withholding and treaty benefits, done right.