Foreign Trusts as Estate Tax Planning Tools

The United States does not only tax income as it is earned — it also imposes a federal estate tax on wealth transferred at death, and this tax reaches well beyond US citizens. Foreign nationals who hold US-situated assets, including many Indian residents who invest in US stocks or real estate, can find themselves subject to US estate tax at rates of up to 40%, often with far less protection than they expect.

Key Takeaways

• The US levies estate tax on the worldwide assets of US persons and on US-situs assets of non-US persons at death.
• Transferring assets into an irrevocable trust can remove them from the transferor’s taxable estate, but only if certain retained powers (“strings”) are avoided.
• Strings include retained control over beneficiaries, retained powers of appointment, and retained ability to change or revoke the trust.
• US citizens/domiciliaries face gift tax on transfers to an irrevocable trust; non-US citizens/domiciliaries generally do not.
• Foreign trusts with US transferors or beneficiaries carry additional complexity: continued grantor income tax treatment, throwback tax on accumulated distributions, and extensive reporting via Forms 3520 and 3520-A.

Introduction

Many Indian residents investing in US equities, mutual funds, or real estate focus primarily on income tax withholding and capital gains treatment, giving little thought to what happens to those assets on death. Yet the US estate tax regime operates entirely independently of income tax, and it applies not only to US citizens but to any individual regardless of nationality or place of residence — who owns property considered to have a US “situs.” Because the exemption available to non-US persons is dramatically smaller than the exemption available to citizens, this is one of the most consequential and least understood risks facing Indian investors with US holdings.

How US Estate Tax Works

The underlying concept is straightforward. When an individual passes away, the fair market value of their relevant assets is aggregated as of the date of death. After allowable deductions, the resulting taxable estate is subject to federal estate tax at graduated rates reaching a top marginal rate of 40%. The critical variable that determines the scope of assets captured and the size of the exemption available is the decedent’s citizenship and domicile status.

US Citizens and Domiciliaries

For US citizens and individuals domiciled in the United States, estate tax is levied on the decedent’s worldwide assets, regardless of where those assets are physically located. However, this broad scope is offset by a substantial lifetime exemption: $13.99 million per individual for 2025, scheduled to rise to $15 million in 2026 under the One Big Beautiful Bill (OBBB) Act.[2] As a practical matter, this generous exemption means the vast majority of US citizens and domiciliaries never pay any federal estate tax at all.

Non-US Citizens and Non-US Domiciliaries

The picture is starkly different for individuals who are neither US citizens nor domiciled in the United States — a category that includes most Indian residents who are Indian citizens and have never established a US domicile.
For this group:
Estate tax applies only to US-situs assets, not worldwide assets.

The available exemption is only $60,000 — a figure that has remained fixed for decades and is a small fraction of the exemption available to US citizens and domiciliaries.

US-situs assets typically include US real estate, tangible personal property located in the United States, and shares of US corporations (including US-listed stocks held directly), among other categories. The narrower scope of assets captured is of limited comfort given how modest the $60,000 exemption is relative to typical investment portfolio sizes.

State-Level Estate Taxes

In addition to the federal regime, a number of US states impose their own separate estate or inheritance taxes. These state-level exemptions are frequently far less generous than the federal exemption, meaning that an estate which owes little or no federal estate tax could still face a meaningful state-level liability depending on where the underlying assets particularly real estate are located.

Illustrating the Exposure

The gap between the citizen exemption and the non-citizen/non-domiciliary exemption becomes concrete with a simple example. Consider an Indian resident who is not a US citizen and holds a portfolio of US assets stocks, securities, or real estate worth $1 million at the time of death. After applying the available deductions, the taxable estate might be reduced to approximately $940,000. At the 40% top marginal estate tax rate, this produces an estate tax bill of roughly $376,000 more than a third of the total portfolio value payable to the US Treasury before the assets can pass to heirs.

This outcome frequently surprises Indian investors, who may be well aware of US capital gains and dividend withholding rules but unaware that a separate, and potentially far larger, tax liability arises entirely on account of death, independent of any income the assets generated during the owner’s lifetime.

Practical Implications for Indian Residents

For Indian residents holding, or planning to acquire, US stocks, real estate, or other US-situs property, several practical points follow from this framework:

The size and composition of a US asset portfolio should be evaluated not only for income tax efficiency but for estate tax exposure, given how quickly a $60,000 exemption can be exceeded.

Direct ownership of US-situs assets — particularly real estate — carries the highest estate tax risk, since there is no shield between the individual and the US taxing authority.

Proven planning tools exist to reduce or eliminate this exposure, including holding US assets through non-US corporate structures (commonly referred to as “estate tax blockers”) and the use of trust-based planning solutions, each with their own trade-offs around income tax, transfer tax, and administrative complexity.

Applicable estate and gift tax treaties between the United States and certain countries can, in some cases, modify the situs rules or exemption amounts, though India does not currently have such a treaty with the United States, leaving Indian residents fully exposed to the default $60,000 exemption regime.