Under a valid trust, the grantor must give up control of income and assets. The independent trustee manages the trust, holds legal title to trust assets and exercises independent control. Trust taxation Under federal tax law, a trust is generally a separate entity subject to tax on the income it receives, including income generated by property held in the trust. A domestic trust must file Form 1041, U.S. Income Tax Return for Estates and Trusts. All income a trust receives, whether from domestic or foreign sources, is taxable to the trust, to the beneficiary or to the taxpayer unless specifically exempted by the Internal Revenue Code.
Foreign trusts are subject to special requirements.
Foreign trusts may be required to file other forms as well. Foreign trusts to which a U.S. taxpayer has transferred property are treated as grantor trusts as long as the U.S. taxpayer is alive and the trust has at least one U.S. beneficiary. The income the trust receives is taxable to the transferor under the grantor trust rules. The courts have held many trust arrangements to be shams, with no economic substance. The resulting income and expenses are attributed to the actual earner of the income.