Cross-Border Trusts Between Canada and the US: How Both Countries Tax Trust Income

A trust that touches both Canada and the US creates one of the most complex cross-border tax situations. The two countries have fundamentally different approaches to trust taxation. The US distinguishes between grantor trusts (transparent: income taxed to the grantor) and non-grantor trusts (opaque: income taxed to the trust or beneficiary). Canada uses a different transparency model: the trust is generally a separate taxpayer, but certain attribution rules push income back to the settlor or attribute it to beneficiaries. When a trust has a US-person grantor, a Canadian-resident trustee, and beneficiaries in both countries, the potential for double taxation, unexpected inclusions, and reporting penalties is significant.

How does the US tax trusts?

The US divides trusts into two categories based on where the income is taxed:

Grantor trusts: Under IRC 671-679, if the grantor (the person who created and funded the trust) retains certain powers or interests (the right to revoke, the right to income, the power to control beneficial enjoyment), the trust is a “grantor trust” and all income is taxed to the grantor as if the trust does not exist. A revocable living trust is the most common grantor trust. The trust does not file its own return (or files a bare-bones Form 1041 with a statement directing the IRS to the grantor’s return).

For foreign trusts, IRC 679 expands the grantor trust rules: any US person who transfers property to a foreign trust that has or could have US beneficiaries is treated as the owner of the trust. This is much broader than the domestic grantor trust rules. The presumption is that a foreign trust with any US beneficiary is a grantor trust as to the US transferor, and the transferor must include all trust income on their personal return.

Non-grantor trusts: If the grantor is not treated as the owner (either because they have died, relinquished all powers, or are not a US person), the trust is a non-grantor trust. A domestic non-grantor trust pays tax on undistributed income at compressed rates (reaching the top 37% bracket at just $15,200 of income for 2025). Distributions to beneficiaries carry out distributable net income (DNI) and are taxed to the beneficiaries.

For foreign non-grantor trusts, distributions to US beneficiaries are taxable under a punitive “throwback” regime: accumulated income distributed in a later year is taxed as if it had been distributed in the year it was earned, with an interest charge for the deferral. This throwback tax can make accumulated distributions from foreign trusts extremely expensive.

How does Canada tax trusts?

Canada treats trusts as separate taxpayers. A trust files a T3 Trust Income Tax and Information Return and pays tax on income retained in the trust at the top marginal rate (which is the highest combined federal/provincial rate, reaching over 53% in Ontario).

Income paid or payable to beneficiaries: The trust can deduct income paid or payable to beneficiaries during the year. The beneficiary includes the income in their own return and pays tax at their personal rate. This creates an incentive to distribute income: the trust avoids the top-rate tax, and the beneficiary pays at a potentially lower rate.

Attribution rules: Canada’s attribution rules (ITA 74.1, 74.2, 75(2)) can push income back to the person who transferred property to the trust. The most important is the “reversionary trust” rule under ITA 75(2): if property can revert to the settlor, or if the settlor can direct the trust’s income or property, all trust income from that property is attributed back to the settlor. This rule is extremely broad and can apply to trusts where the settlor is a trustee or has any influence over distributions.

21-year deemed disposition: Every 21 years, a Canadian-resident trust is deemed to have disposed of all its capital property at FMV (ITA 104(4)). This triggers a capital gains tax event, preventing the indefinite deferral of gains within a trust. There is no comparable rule in the US, which creates a planning opportunity (and a cross-border mismatch) for trusts that straddle the border.

What are the cross-border problems?

Problem 1: Different taxpayer for the same income. A US-person grantor who creates a Canadian-resident trust is taxed on all trust income in the US (grantor trust under IRC 679). Canada taxes the trust itself (or the beneficiaries, if income is distributed). The foreign tax credit is supposed to prevent double taxation, but the mismatch in taxpayer identity (grantor in the US, trust or beneficiary in Canada) complicates the credit calculation. The IRS credits Canadian tax paid by the trust against the grantor’s US tax, but only to the extent the Canadian tax is attributable to the income included in the grantor’s US return.

Problem 2: Throwback tax on accumulated distributions. A Canadian trust that accumulates income for years and then distributes it to a US beneficiary triggers the throwback tax. The beneficiary pays US tax as if the income had been distributed in the year it was earned, plus an interest charge for the deferral. If the trust was paying Canadian tax at the top rate all along, the US throwback tax may be partially offset by foreign tax credits, but the interest charge is not creditable.

Problem 3: Reporting penalties. A US beneficiary who receives a distribution from a foreign trust must report it on Form 3520. Failure to file: 35% of the distribution as a penalty. A US person who transfers property to a foreign trust must also file Form 3520. Failure to file: 35% of the transfer amount. The trust itself (if it has a US owner or agent) must file Form 3520-A, with a $10,000 penalty for failure. These penalties apply even if no tax is owed.

What trust structures work across the border?

Revocable living trusts (US-style): A US person’s revocable living trust is a grantor trust for US purposes (tax-transparent). If the grantor moves to Canada, the trust becomes a “foreign trust” from the US perspective if the trustee is in Canada, but it remains a grantor trust as to the US-citizen grantor (who continues filing US returns). Canada may treat the trust as a separate taxpayer, but the attribution rules under ITA 75(2) may push all income back to the settlor/grantor anyway, since the trust is revocable (the property can revert to the settlor). The result: both countries tax the grantor, and foreign tax credits prevent double taxation.

Testamentary trusts (trust created on death): When a person dies and their will creates a trust, the trust is a testamentary trust. In Canada, testamentary trusts are taxed at graduated rates for the first 36 months (a “graduated rate estate” or GRE) and at the top marginal rate thereafter. In the US, a testamentary trust is a non-grantor trust (the grantor is deceased). If the beneficiaries are in the other country, the cross-border reporting and taxation issues apply.

Inter vivos trusts (lifetime trusts): These are the most problematic cross-border. A Canadian resident who creates an inter vivos trust with a US-resident beneficiary may not realize that the US will treat the trust as a foreign non-grantor trust, subjecting the beneficiary to throwback taxation and Form 3520 reporting. A US person who creates an inter vivos trust and moves to Canada triggers the 21-year deemed disposition rule (if the trust becomes a Canadian-resident trust).

Trust migration: Moving a trust from one country to another (by changing the trustee’s residence) can trigger tax consequences in both countries. Moving a US trust to Canada can trigger the 21-year clock and Canadian reporting obligations. Moving a Canadian trust to the US can trigger Canadian departure tax (deemed disposition) and change the US classification of the trust.

What reporting is required?

US reporting:

• Form 3520: US persons report transfers to foreign trusts (Part II) and distributions from foreign trusts (Part III). Due with the individual return (April 15, with extensions). Penalty: 35% of the transfer or distribution for failure to file.
• Form 3520-A: Annual information return of a foreign trust with a US owner. Filed by the trust (or the US owner, if the trust does not file). Due March 15. Penalty: 5% of the trust’s gross assets for failure to file, minimum $10,000.
• FBAR (FinCEN 114): Foreign trust accounts may be reportable if the US person has a financial interest or signature authority.
• Form 8938: Foreign trust interests are specified foreign financial assets.

Canadian reporting:

• T3 Trust Income Tax and Information Return: Filed by the trustee for a Canadian-resident trust. Due 90 days after the trust’s year-end.
• T1142 (Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust): Filed by Canadian-resident beneficiaries who receive distributions from a non-resident trust.
• NR4 (Statement of Amounts Paid or Credited to Non-Residents of Canada): Filed by a Canadian-resident trust that makes distributions to non-resident beneficiaries, to report the withholding tax.

Related guides:

• Form 3520 Penalty Abatement covers the IRS policy shift on reasonable cause relief for late Form 3520 filings
• Form 3520-A: Who Files and the March 15 Deadline covers the annual information return that foreign trusts with US owners must file
• Canadian Trust with a US Beneficiary covers how the US taxes distributions from a Canadian trust to a US-resident beneficiary
• Is a TFSA a Foreign Trust? covers why the IRS treats registered Canadian accounts as foreign trusts
• FBAR Filing Requirements covers who must file FinCEN 114 and the $10,000 aggregate threshold
• Deemed Disposition at Death: Canada vs US Step-Up in Basis covers how the 21-year deemed disposition and death-year rules interact with US basis
• Cross-Border Estate Planning: Freezes, Alter Ego, and Bypass Trusts covers planning structures that coordinate trust taxation across both countries

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.