Ashford International Law P.C.

Summary

1. A trust separates the legal ownership of assets, held by a trustee, from the benefit of those assets, which goes to the beneficiaries. It is the central instrument of American estate planning and has no counterpart in German civil law.
2. The most important distinction is between a revocable trust, which the settlor can change or end at any time and which is disregarded for estate and income tax purposes during the settlor’s life, and an irrevocable trust, which can remove assets and their future growth from the settlor’s taxable estate.
3. For income tax purposes a trust is either a grantor trust, whose income is taxed to the settlor, or a separate taxpayer. A separate trust reaches the top federal rate of 37 percent at $16,000 of retained income in 2026, so income is usually distributed or the trust is structured as a grantor trust.
4. Whether a trust is domestic or foreign depends on two tests, a court test and a control test. A single foreign trustee or a trustee’s move abroad can turn a domestic trust into a foreign one, with a separate and far stricter set of rules.
5. Germany taxes the funding of a trust, distributions from it and its dissolution as separate transfers, generally in the least favorable tax class. A trust that works well for an American family can be expensive once the settlor or a beneficiary lives in Germany.
6. A trust is not always needed. It is most useful where there is real estate in several states, a non-citizen spouse, young or vulnerable beneficiaries, a blended family or a need for privacy, and it has to be tested against the law of every country in which the family lives or holds assets.

Part I. What a trust is, and how two legal systems see it

A trust is created when a person, the settlor (also called the grantor or trustor), transfers assets to a trustee, who holds and manages them for one or more beneficiaries under the terms of a written trust instrument. The trustee owns the assets in law but must use them solely in the beneficiaries’ interest, and the beneficiaries can enforce that duty in court. The settlor may also be a trustee and a beneficiary, which is the usual arrangement in a revocable living trust. Most American states have adopted the Uniform Trust Code, which sets out the trustee’s duties of loyalty, prudence, impartiality and disclosure; the District of Columbia, Maryland and Virginia have each enacted a version of it, and California has its own Probate Code rules to the same effect.

German law has no trust. The civil law distinguishes ownership from limited rights in property, and a division of ownership into a legal and a beneficial title does not fit that system. German law reaches similar results through other instruments: the executor with long-term administration powers (Testamentsvollstreckung, §§ 2197 et seq. BGB), the prior and subsequent heir (Vor- und Nacherbschaft, §§ 2100 et seq. BGB), the fiduciary arrangement (Treuhand) and the family foundation (Familienstiftung). Germany has not ratified the Hague Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition, and the European Succession Regulation expressly excludes trusts from its scope (Art. 1(2)(j) Regulation (EU) No 650/2012). A German court or tax office therefore looks at what an American trust does in the individual case and fits it into German categories, often with unexpected results.

Part II. Types of trusts

Trusts are named after their purpose or their tax treatment, and one trust often carries several labels at once: a revocable living trust becomes, at the settlor’s death, the irrevocable trust that holds a credit shelter share and a marital share. The following table lists the types that appear most often in the firm’s cross-border work.

Most trusts also contain a spendthrift clause, which prevents a beneficiary from assigning an interest and protects it from the beneficiary’s creditors, and many give an independent trustee or a trust protector the power to adapt the terms to later changes in the law or in the family.

Part III. Revocable trusts and irrevocable trusts

A revocable trust is a will substitute. The settlor keeps full control, can take the assets back at any time and is taxed as if the trust did not exist. Its advantages are practical: assets titled in the trust pass at death without probate, which matters most where the settlor owns real estate in several states and would otherwise need an ancillary probate in each of them; the successor trustee can act at once if the settlor becomes incapacitated; and the terms of the trust, unlike a probated will, do not become a public record. A revocable trust offers no protection from the settlor’s creditors and no estate tax saving, because the assets remain in the settlor’s estate.

An irrevocable trust cannot be changed by the settlor alone. The transfer into it is a completed gift if the settlor keeps no power to change the beneficial interests (Treas. Reg. § 25.2511-2), uses the gift tax exemption or incurs gift tax, and removes the asset and its future growth from the settlor’s estate unless the settlor keeps an interest or a power that pulls it back in (IRC §§ 2036 to 2038). The price is the loss of control, and in most cases the loss of the step-up in income tax basis at death, because only assets included in the estate receive a new basis (IRC § 1014).

At the settlor’s death a revocable trust becomes irrevocable. From that moment it is a separate taxpayer, it obtains its own employer identification number, and the successor trustee takes on the full duties of administration described on the page on fiduciary services.

Part IV. Taxation of trusts in the United States

Grantor and non-grantor trusts. A trust is a grantor trust if the settlor keeps one of the powers or interests listed in IRC §§ 673 to 677, for example the power to revoke, the power to substitute assets of equal value, or the right to have income paid to the settlor or the settlor’s spouse. Its income, deductions and credits are reported on the settlor’s own return. Every other trust is a separate taxpayer that files Form 1041. It deducts the income it distributes, up to its distributable net income (IRC §§ 643(a), 651, 661), and the beneficiaries report that income on the Schedule K-1 they receive. Distributions made within 65 days after the end of the year may be treated as made in that year (IRC § 663(b)).

Rates. Retained income is taxed on a compressed schedule, and the 3.8 percent net investment income tax applies from the same threshold (IRC § 1411(a)(2)).

State income tax is added on top. Several states tax a trust by reference to the residence of its settlor, trustee or beneficiaries; California, for example, taxes trust income by reference to the residence of the fiduciaries and of beneficiaries whose interests are not contingent (Cal. Rev. and Tax. Code § 17742). The choice of trustee and of the trust’s situs is therefore also a state tax decision.

Domestic and foreign trusts. A trust is a United States trust only if a United States court can exercise primary supervision over its administration and one or more United States persons control all of its substantial decisions (IRC § 7701(a)(30)(E); Treas. Reg. § 301.7701-7). A trust that fails either test is a foreign trust. The consequences are severe. A United States person who transfers property to a foreign trust with a United States beneficiary is treated as its owner (IRC § 679); a transfer to a foreign non-grantor trust is treated as a sale, with gain recognized (IRC § 684); accumulated income distributed later is subject to the throwback tax and an interest charge (IRC §§ 665 to 668); and transactions with the trust must be reported on Forms 3520 and 3520-A, with penalties of at least $10,000 for each failure (IRC § 6677). A domestic trust can become foreign without anyone intending it, when a trustee or a person holding a veto power moves abroad or a foreign co-trustee is appointed. Trust instruments for international families should therefore contain a clause that removes or replaces such a person automatically.

Gifts and inheritances from abroad. A United States person who receives more than $100,000 in a year in gifts or bequests from a nonresident individual or a foreign estate must report them on Form 3520, although no tax is due on the receipt itself (IRC § 6039F); distributions from a foreign trust are reported on the same form regardless of amount (IRC § 6048(c)). The reporting obligations of trusts and their fiduciaries are described on the page on tax compliance.

Part V. Trusts and Germany

German inheritance and gift tax treats a trust as an asset pool of foreign law (Vermögensmasse ausländischen Rechts). Three events are taxed separately: the transfer of assets into the trust, whether during life or at death (§ 7(1) no. 8 sentence 2 and § 3(2) no. 1 sentence 2 ErbStG); distributions to beneficiaries during the term of the trust (§ 7(1) no. 9 sentence 2 ErbStG); and the assets received when the trust ends (same provision). The funding of the trust is generally taxed in tax class III, with an allowance of only €20,000 and rates of 30 percent and 50 percent, because the trust itself, not the family member behind it, is the recipient. German tax applies if the settlor or the recipient is resident in Germany, and German citizens remain fully taxable for five years after leaving (§ 2(1) no. 1 ErbStG).

The German courts have limited the charge on funding where the settlor keeps full control over the trust assets, treating those assets as still belonging to the settlor. A revocable American living trust is often viewed that way. That avoids tax on funding but means that the assets are taxed as part of the settlor’s estate at death, and the passing of the assets to the beneficiaries through the then irrevocable trust must be analyzed again.

For income tax, the income of a foreign family trust may be attributed to a settlor resident in Germany, or, failing that, to beneficiaries resident in Germany, whether or not anything is distributed (§ 15 AStG). Distributions not covered by that attribution can be taxable as investment income. The estate and gift tax treaty between the United States and Germany of 1980 applies to transfers into and out of trusts, but its tie-breaker and credit rules were not written with trusts in mind and do not remove every double charge.

Three situations arise regularly: an American family trust with a child who moves to Germany for work or study; an American settlor who retires to Germany while a revocable trust holds the family’s assets; and a German family that inherits from an American relative through a trust. In each case the distribution policy, the trustee’s powers and the timing of any transfer can be adapted before the German tax is triggered, but rarely afterward. The firm’s detailed guides on a U.S. trust with a beneficiary in Germany, moving to Germany with a U.S. trust and distributions to a beneficiary in Germany set out the German analysis in full.

Part VI. When a trust is needed

A trust is a tool, not a requirement. A will, beneficiary designations and joint titles are sufficient for many families. A trust is usually worth its cost in the following situations:

• real estate in more than one state, where a revocable trust avoids a separate probate in each state;
• a surviving spouse who is not a United States citizen, where a qualified domestic trust is the only way to defer the estate tax at the first death;
• an estate above the basic exclusion amount, or one expected to grow beyond it, where irrevocable trusts move future growth outside the estate;
• minor, young or vulnerable beneficiaries, or a beneficiary with creditor or marital risks;
• a second marriage or children from different relationships, where a trust secures the survivor and still preserves the capital for the first spouse’s children;
• a family business or real estate that should be held together rather than divided among heirs;
• a wish for privacy, since a trust is not filed with the probate court.

A trust is less suitable, or needs a different design, where the settlor or a principal beneficiary lives in Germany or another civil law country that taxes trusts on their own terms, where the assets are mainly retirement accounts that pass by beneficiary designation anyway, or where the family is not prepared to pay a trustee and to follow the formalities of administration. In a cross-border family the question is not whether a trust is useful in the United States, but whether it remains useful after the tax cost in every other country concerned has been added.

Part VII. Practical steps

1. List the assets by country and state, and note how each is titled and whether it passes by beneficiary designation.
2. Establish the domicile and citizenship of the settlor, the spouse and each beneficiary, and where each of them is likely to live in the coming years.
3. Decide whether the aim is probate avoidance and incapacity planning, for which a revocable trust suffices, or estate tax reduction and protection, which requires an irrevocable trust.
4. If the spouse is not a United States citizen, provide for a qualified domestic trust in the estate plan.
5. Choose trustees and successor trustees with the domestic trust tests in mind, and include a clause that prevents an unintended change to foreign trust status.
6. Where a settlor or beneficiary lives in Germany or may move there, have the German inheritance, gift and income tax consequences of funding and of each form of distribution analyzed before the trust is signed.
7. Retitle the assets into the trust; an unfunded revocable trust avoids no probate.
8. Review the trust after every move, marriage, birth, death or change in the law.

Conclusion

The trust is the most flexible instrument American law offers for holding family wealth across generations, and its tax treatment in the United States is predictable once the grantor, domestic trust and estate inclusion questions are answered. In an international family, however, the same trust is assessed a second time under a legal system that does not know it and taxes it by analogy. The trust therefore has to be designed for both systems at once: with trustees who keep it domestic, with distribution provisions that work in the beneficiaries’ countries of residence, and with a clear view of what each transfer into and out of the trust will cost abroad.

How the firm helps

Ashford International Law PC drafts revocable and irrevocable trusts for families with ties to the United States and Western Europe, designs qualified domestic trusts for non-citizen spouses, reviews existing American trusts before a settlor or beneficiary moves to Germany, advises trustees on administration, distributions and reporting, and acts as trustee or successor trustee where appropriate. Related pages on this site cover international estate planning, estate planning for non-US citizens, non-US beneficiaries, asset protection, gift and death-related taxes, fiduciary services, business succession planning and, for banks and trust companies, services for financial institutions. The firm’s detailed guides on the German treatment of American trusts, on FATCA classification of trusts and estates and on FBAR and Form 8938 obligations of fiduciaries are available on the Articles and Guides page, and defined terms are collected in the Topics A-Z.

This page is intended for general educational purposes and does not constitute legal or tax advice, nor does it create an attorney-client relationship. The matters described depend on the specific facts, the countries and states concerned, and the law in effect at the relevant time. Figures are stated as of September 2026 and must be confirmed before any decision.