How Are Family Trusts Taxed in Australia for U.S. Citizens? The Overlooked Risks and Surprising Savings No CPA Warns You About

Most U.S. citizens believe moving wealth into an Australian family trust will shield them from double taxation. The reality: this common tactic often exposes families to IRS audits, six-figure penalties, and complex compliance headaches—unless you know the precise intersections of U.S. and Australian tax law.

For 2025 and beyond, if you’re a U.S. citizen with family members or business interests in Australia, misunderstanding the cross-border tax rules can lead to surprise tax bills and paperwork nightmares from both countries. But, with strategic planning, the modern U.S.-Australia tax landscape also offers unique opportunities to limit double-taxation, preserve wealth, and even unlock tax savings. Here’s how it works in plain English, with zero fluff—and why the unique rules for U.S. citizens make family trusts a potential minefield.

Quick Answer: How Are Family Trusts Taxed for U.S. Citizens in Australia?

Family trusts in Australia are generally taxed as flow-through entities, shifting income to beneficiaries for assessment at individual rates. But for U.S. citizens—no matter where they live—the IRS taxes worldwide income as if you were still living in California. This means if a U.S. citizen is a beneficiary (or sometimes even just related to one) in an Australian family trust, every dollar distributed or retained may trigger U.S. tax (at up to 37% plus potential extra state tax), plus complex reporting.

When evaluating how are family trusts taxed in Australia US citizen compliance, the key is that the U.S. treats all such trusts as “foreign trusts” under IRC §679. That means even if you pay 45% tax in Australia, the IRS still requires full disclosure via Forms 3520 and 3520-A before any foreign tax credits are applied. You can only offset those credits through Form 1116—never automatically. The IRS considers timing and classification critical: if income is not distributed in the same year it’s earned, “throwback” taxes and interest charges can apply years later.

How the U.S. and Australian Tax Systems Collide on Family Trusts

Australian family trusts (“discretionary trusts”) are a staple of wealth management for families and business owners, commonly used to split income among family members to lower group tax rates. Here’s what U.S. citizens need to know:

• Australia: The trust itself is generally not taxed (unless income accumulates). Income is “flowed through” to beneficiaries, who pay tax at individual rates. Australian tax rates can reach up to 45% for high earners.
• U.S.: For U.S. citizens, all global income is reported, including trust distributions, via IRS Form 1040. Family trusts typically require extra disclosures—think IRS Forms 3520 and 3520-A—plus reporting for “grantor” or “foreign” trust rules. Failure to file on time is a $10,000+ minimum penalty (per form, per year).

The tangled part: In many cases, U.S. rules treat Australian family trusts as “foreign grantor trusts”—even if you only receive a check once a year as a beneficiary living abroad.

A key nuance in how are family trusts taxed in Australia US citizen situations is that “grantor” status doesn’t depend on control—it depends on who originally funded or benefits from the trust. If any U.S. person funded or retains control rights, the IRS can tax all undistributed income annually, even if that income stays in Australia. This creates a mismatch: Australian law may defer tax until distribution, but U.S. law taxes current-year income regardless of payout. Strategic structuring—often through irrevocable or excluded grantor setups—can narrow this mismatch but must be carefully documented each tax year.

KDA Case Study: Dual Citizen, Dual Tax Headache—$69K Saved with Strategic Reporting

Megan, a 38-year-old business owner with U.S.-Australia dual citizenship, inherited a stake in her family’s Brisbane trust. The trust owned $2 million in Australian property and paid out $85,000 annually to multiple family members, including Megan (now residing in San Jose, CA).

Before working with KDA, Megan’s U.S. accountant reported her $17,000 annual distribution as regular income on her IRS Form 1040—but missed the required IRS Form 3520 reporting since the trust was foreign from the U.S. perspective. In 2023, the IRS issued a $20,000 penalty notice for two missed compliance years—and threatened tax on the gross trust income (not just the distribution).

KDA stepped in, filing streamlined compliance for late IRS Form 3520s and working with an Australian CPA to substantiate all distributions. Megan’s total penalty after abatement dropped to $2,200—a $17,800 savings. Going forward, KDA created a reporting protocol: she submits all trust statements quarterly, uses IRS Treaty Exception rules to properly credit foreign taxes paid, and maintains clean separation between U.S. and Australian bank accounts. In 2024, Megan paid $12,800 total U.S. tax instead of $26,400 (over $13.6K saved annually, plus penalty abatement), and her Australian family got peace of mind.

Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.

Pro Tip: Dual Reporting—The Overlooked Trust Trap

Most U.S. advisors ignore the IRS requirement to file both Form 3520 and 3520-A for every year a U.S. person is a trust beneficiary—even if no distribution is made. Failing this double filing is the top red flag for automatic IRS penalties. See IRS instructions for Form 3520-A.

Australian Family Trust Income: When and How the IRS Gets Involved

Let’s break down how an Australian discretionary trust triggers U.S. tax obligations for citizens and green card holders—no matter where they live.

Income Distribution Flows

• If you’re a U.S. citizen beneficiary, any Australian distribution—cash, shares, or even property—must be reported annually to the IRS on your 1040 plus Form 3520.
• If the trust accumulates income and does not distribute, U.S. anti-deferral rules may still tax you if the IRS deems you to have “constructive receipt.” This is often misunderstood by Australian-only accountants.

Filing Requirements

• Form 3520: Filed by U.S. citizen for any receipt of trust income, even if received abroad or via reinvestment. Late filing is subject to automatic penalty ($10,000+ per event, per year).
• Form 3520-A: Filed by trust, but U.S. beneficiary is responsible for ensuring it’s done—if not, the penalty comes back to the beneficiary.
• FBAR/FinCEN 114: Report all foreign financial accounts (including trust-held accounts) if cumulative value goes above $10,000 USD.

For cross-border families analyzing how are family trusts taxed in Australia US citizen scenarios, the 3520-A obligation is often misunderstood. The IRS assigns responsibility to the U.S. beneficiary even when the trustee is entirely Australian. If the trustee fails to file, the U.S. beneficiary must self-report using a “substitute” Form 3520-A to avoid penalties. This step alone can eliminate a $10,000 fine and maintain eligibility for penalty abatement under the IRS’s Reasonable Cause provisions.

Common scenario: U.S. expat receives $8,000 distribution from an Australian family trust in 2024, pays $2,800 in Australian tax, but forgets to file Form 3520 by April 15. Result: IRS demands $10,000 penalty and may deny foreign tax credit. The fix? You must properly coordinate with the trust’s Australian accountant AND your U.S. tax advisor each year—KDA often acts as the bridge, filing all forms on time and arguing for penalty relief where justified. See our California guide to estate/legacy tax planning for more in-depth cross-border strategies.

IRS Foreign Grantor Trust Rules: Why U.S. Citizens Get Extra Scrutiny

Australian family trusts are almost always considered “foreign” by the IRS. This triggers harsh, extra-complex reporting and taxes. Under IRS rules (see IRS Publication 3520 instructions):

• U.S. citizen grantors (creators of the trust) are taxed on all trust income, even if it stays in Australia.
• If the grantor is a non-U.S. person but a U.S. citizen is a beneficiary, distributions are still fully taxable and must be reported as foreign trust income.
• Accumulated income that’s later distributed to a U.S. beneficiary may be hit by punitive “throwback” tax rates, plus interest charges, even if the income was earned years earlier.

Example: If the trust earned $15,000 in dividends that was retained for three years and distributed in 2025, the U.S. beneficiary may owe income tax plus an interest surcharge all the way back to when the income was first generated.

A practical strategy for how are family trusts taxed in Australia US citizen clients is to use “matching year” planning. By distributing Australian trust income in the same tax year it’s earned, U.S. citizens can often neutralize throwback taxes and qualify for immediate foreign tax credits. This approach also improves alignment under Article 22 of the treaty and simplifies Form 1116 reporting. Timing distributions to match the trust’s accounting year is often the difference between standard taxation and compounded penalties.

Why Most U.S. Trustees and Beneficiaries Get Penalized—The Hidden Compliance Gap

The most expensive mistake: assuming your Australian CPA, bank, or family office will alert you to IRS paperwork. In practice, 90% of all penalties arise from three traps:

1. Failure to file IRS Form 3520 and 3520-A every year (even with $0 distribution).
2. Failure to report underlying investment accounts (FBAR/FinCEN 114 violations—triggered once worldwide accounts exceed $10,000).
3. Improper application of the U.S.-Australia tax treaty (often ignored or misunderstood by U.S. tax preparers unfamiliar with foreign trusts).

This is why “do-it-yourself” cross-border estate management rarely succeeds for expat families. The fix: have both a U.S. tax advisor and an Australia-based accountant coordinate each year and review all financial accounts, distributions, and reporting timelines together. KDA uses a verified checklist approach: calendar reminders, tax treaty analysis, simultaneous compliance on both continents, and regular communication with legal and financial planners.

Tax Credits, Treaty Relief, and Double Taxation: What Actually Works (and What Doesn’t)

Here’s the good news: There are scenarios where, with the right forms and timing, you can offset most or all of the double taxation, but only if you meet these conditions:

• Claiming foreign tax credits for Australian tax paid on trust income (via IRS Form 1116), but only if income is classified and reported promptly on all U.S. forms.
• Applying the U.S.-Australia income tax treaty article 18 and 22, which can provide some relief for double-taxed trust income. But, most U.S. preparers and commercial tax software fail to apply Article 22 relief for trusts correctly.
• Use of the annual “foreign earned income exclusion” via IRS Form 2555 does not apply to passive trust income—this is a common misconception among expats.

In practice, how are family trusts taxed in Australia US citizen scenarios hinge on whether you can synchronize the two tax systems. The U.S.–Australia treaty doesn’t override reporting; it only allows credit or timing relief if both returns are filed correctly and on time. Article 22 credits apply only to income taxes—never penalties or interest—so failing to file Form 3520 on time can wipe out treaty benefits entirely. The winning move is aligning Australian trust financials with your U.S. filing calendar and securing pre-approval from both accountants before any distribution is made.

Example: If you receive $20,000 AUD from a family trust, pay $6,200 AUD in Australian tax, and file both IRS Forms 1040 and 1116 correctly, your net U.S. liability can be near zero, but only if paperwork is submitted flawlessly. But fail to file Form 3520 on time, and the IRS begins with a $10,000 penalty before even reviewing your return.

Pro Tip: Coordinate your U.S. and Australian tax filings before distributing any trust income. Timing errors are often more expensive than the taxes themselves.

What If the Australian Family Trust Has U.S. Investments or U.S. Beneficiaries?

Red Flag Alert: If an Australian trust holds U.S. stocks or real estate, or names U.S. persons as trustees or beneficiaries, it may trigger “effectively connected income” or U.S. estate/gift tax exposure. IRS rules for “U.S. situs” assets are complex—additional reporting can be required, and the trust may face 30% withholding tax on certain U.S. income, regardless of distributable net income.

Frequently Asked Questions about U.S. Citizens and Australian Family Trusts

Do Australian Family Trusts Pay Tax Themselves?

No—the trust usually does not pay Australian tax directly if it distributes all income to beneficiaries, who pay at their marginal rates. Undistributed trust income can be taxed at the highest marginal rate in Australia (currently 45%).

Can U.S. Citizens Exclude Australian Trust Distributions from U.S. Taxes?

No. All distributions (and, in some situations, undistributed income) are taxable to U.S. citizens. Only properly documented foreign tax credits or treaty relief can help mitigate double taxation, but you must file all U.S. trust forms on time.

Is There Ever a Way to Avoid U.S. Form 3520/3520-A?

Rarely. If you are a U.S. citizen and a trust beneficiary, expect to file these forms every tax year—regardless of whether you receive a distribution. Criminal penalties can apply for willful non-reporting. See IRS guidance for Form 3520-A for full details.

What About U.S. Citizens Living Full-Time in Australia?

They are still treated as U.S. tax residents for all income worldwide. This means trust distributions are doubly reported, but with careful planning, you can often avoid paying tax twice by maximizing foreign tax credits and applying treaty relief. Filing remains mandatory each year.

Book Your U.S.-Australia Tax Strategy Session

If you’re worried about IRS penalties, double taxation, or missing out on trust income, don’t risk your legacy. Book a confidential strategy session with KDA’s cross-border specialists. We’ll review your trust documents, ensure full compliance, and build a plan to protect every dollar—no matter which side of the world you call home. Click here to book your consultation now.