The Foreign Trust Trap

By Hans Riefkohl, Riefkohl Law • March 2026

There is a question that almost never comes up when Act 60 decree holders discuss their trust planning, and it should: Is your trust still a “domestic trust” in the eyes of the IRS?

If the answer is no—if the IRS considers your trust a “foreign trust”—the consequences are severe. Reporting obligations multiply. You may be required to file Form 3520 annually. Throwback taxation rules can apply. Favorable capital gains treatment may be lost. Penalties for non-compliance are steep and assessed per form, per year.

Most decree holders do not realize that moving to Puerto Rico, by itself, can set in motion a chain of events that causes their mainland trust to fail the IRS’s domestic trust test. This article explains how that happens and what you can do to prevent it.

The IRS Two-Pronged Test: Court Test and Control Test

Under IRC § 7701(a)(30)(E), a trust qualifies as a “domestic trust” only if it satisfies both of the following. These requirements, established by Congress in 1996, are executed through Treasury Regulation § 301.7701-7 and have remained consistent through 2026:

The Court Test: A court within the United States must be able to exercise primary supervision over the administration of the trust. For purposes of this test, under Treasury Regulation § 301.7701-7(c)(3)(ii), “the United States” includes only the 50 States and the District of Columbia. U.S. territories, including Puerto Rico, are not treated as part of the United States for this purpose.

The Control Test: One or more United States persons must have the authority to control all substantial decisions of the trust. U.S. citizens and residents remain “United States persons” for this purpose even if they reside in Puerto Rico or abroad.

If either test fails, the trust is classified as a “foreign trust.” There is no middle ground.

Understanding the Court Test

The Court Test does not require that a U.S. court actually be supervising your trust day-to-day. It requires that a U.S. court be able to exercise “primary supervision” over trust administration. The Treasury Regulations provide a safe harbor: your trust meets the Court Test if the trust instrument does not direct administration outside the United States, the trust is in fact administered exclusively in the U.S., and the trust is not subject to an automatic migration clause that would move administration offshore upon certain triggering events.

There is an important nuance here. The regulations recognize that the Court Test can be met even if a foreign court is also able to exercise supervision—as long as a U.S. court is also able to exercise primary supervision. The test is not about exclusivity. It is about whether a U.S. court has the ability to serve as the primary supervisor if called upon.

“Primary Supervision” Is More Demanding Than Ordinary Jurisdiction

This is a distinction many advisors miss. “Primary supervision” is not the same as ordinary minimum contacts jurisdiction. Minimum contacts jurisdiction—the kind analyzed under International Shoe and its progeny—requires only that a party have sufficient contacts with a forum so that maintaining a lawsuit there does not offend traditional notions of fair play. It is a relatively low bar.

Primary supervision is a higher standard. It implies an ongoing ability to oversee trust administration: to appoint and remove trustees, require accountings, adjudicate disputes between beneficiaries, and approve or disapprove administrative actions. A court exercises this kind of continuing supervisory jurisdiction when the trust was established within its territory, when the trust’s principal place of administration is there, or when the trust has been registered in that jurisdiction.

Under the Uniform Trust Code (adopted in many states), the principal place of administration is tied to the trustee’s location or the place where administration actually occurs. This is a fundamental principle: a trust’s primary jurisdiction follows the trustee and the actual conduct of trust administration. This means that where your trustee sits and where the day-to-day work of managing the trust happens are the key determinants of which court can exercise primary supervision.

How Moving to Puerto Rico Creates the Risk

When you move to Puerto Rico and hold an Act 60 decree, you are focused on establishing bona fide residency for tax purposes. You are satisfying the three IRC §937 requirements: the 183-day presence test, the tax home test, and the closer connection test. You are building your life on the island.

But your trust’s IRS classification depends on where the trust lives, not where you live. And here is the problem: if you are the sole trustee and you have moved to Puerto Rico, the trust’s administration has effectively moved with you. If you manage the trust’s investments from San Juan, make distribution decisions from your home in Guaynabo, and keep the trust records in your office in Dorado, the trust’s principal place of administration is Puerto Rico.

At that point, which U.S. state court can exercise primary supervision? If the trustee is in Puerto Rico, the assets are in Puerto Rico, and the administration is occurring in Puerto Rico, the answer may be: none of them. And if no U.S. state court can exercise primary supervision, the Court Test fails.

The Control Test: Usually Easier, But Watch for Complications

The Control Test requires that one or more U.S. persons have authority to control all substantial decisions of the trust. “Substantial decisions” includes decisions about distributions, investment allocation, whether to terminate the trust, whether to compromise claims, and similar matters.

For most Act 60 decree holders, the Control Test is easier to satisfy. You are a U.S. citizen (or U.S. person) and you typically retain authority over the trust’s substantial decisions, either as trustee, trust protector, or through retained powers. As long as the persons with authority over all substantial decisions are U.S. persons, the Control Test is met.

However, there is an indirect complication. If you are the sole person with authority over substantial decisions and you reside in Puerto Rico, that concentration of control in PR may strengthen a PR court’s claim to jurisdiction over the trust—which in turn may weaken a U.S. state court’s basis for exercising primary supervision. The Control Test and the Court Test can work at cross-purposes when the controlling person resides outside the fifty states.

The Three-Legged Stool: Why Everything Depends on the Same Contacts

Your trust faces three simultaneous requirements after you move to Puerto Rico: maintaining U.S. state governing law, preserving U.S. state court jurisdiction (for the IRS Court Test), and avoiding foreign trust classification. These three requirements form a three-legged stool, and all three legs rest on the same foundation—genuine contacts with a U.S. state.

Governing law depends on contacts. To keep your trust governed by Delaware, Florida, or Nevada law, the trust needs a “substantial relation” to that state. If all real contacts have migrated to Puerto Rico, the governing law clause in your trust instrument becomes vulnerable.

Jurisdiction depends on contacts. For a U.S. state court to exercise primary supervision, the trust must have real contacts in that state—a trustee located there, assets held there, administration occurring there. A governing law clause alone does not establish jurisdiction.

IRS classification depends on jurisdiction. The Court Test requires that a U.S. court be able to exercise primary supervision. If no U.S. state court has the basis for it, the test fails and your trust becomes foreign.

All three requirements depend on the same underlying contacts: where the trustee is, where the assets are, where administration happens. Lose those contacts and you jeopardize all three legs of the stool at once.

Three Common Scenarios

Scenario 1: You Keep Your Mainland Trustee and Administration in Place

You created a revocable trust in Delaware with a Delaware corporate trustee. After moving to Puerto Rico with your IRI decree, you retain the Delaware trustee and leave administration in Delaware. Your trust assets remain in Delaware-based accounts.

This is the strongest position. The governing law clause is supported by real contacts. The Delaware court can exercise primary supervision because the trustee and administration are there. The Court Test is satisfied. Delaware Code § 3547(c) provides an additional statutory shield against PR-law challenges to the trust’s Delaware status.

Scenario 2: You Replace Your Trustee with Yourself

Same starting point, but after moving to Puerto Rico you remove the Delaware trustee and name yourself as sole trustee. You manage the trust from your PR home, move the investment accounts to a PR institution, and handle all administration locally.

This is the danger zone. The only remaining connection to Delaware is the governing law clause. A PR court could have stronger jurisdictional claims than a Delaware court. No Delaware court can exercise primary supervision when there is nothing in Delaware for it to supervise. The Court Test will likely fail. Critically, satisfaction of the Control Test alone does not rescue the trust—failure of the Court Test is sufficient by itself to cause the trust to be classified as foreign, regardless of whether the Control Test is met. All three legs of the stool are at risk.

Scenario 3: You Create a New Trust Under PR Law

Instead of relying on your mainland trust, you create a new revocable trust under Puerto Rico law pursuant to Section 45147(b). PR law governs from the start, so there is no choice-of-law conflict.

The IRS classification question becomes: does a Puerto Rico court qualify as a “court within the United States” for the Court Test? If it does, this trust can satisfy both prongs. If it does not, you would need to maintain sufficient contacts with a U.S. state—which may require a U.S.-based co-trustee or dual-situs arrangement—to ensure a U.S. state court can also exercise primary supervision. This scenario warrants careful analysis with both a Puerto Rico attorney and a federal tax advisor.

Practical Steps to Protect Your Trust’s Domestic Status

The checklist for maintaining IRS domestic trust classification overlaps substantially with the checklist for maintaining governing law (discussed in my companion article on mainland trusts in Puerto Rico). The same contacts serve both purposes:

Keep a U.S.-state trustee or co-trustee. An institutional trustee in the state designated in your trust instrument is the single most effective safeguard. It anchors both the governing law connection and the Court Test.

Ensure real administration occurs in the U.S. state. Record-keeping, investment decisions, accountings, and correspondence should originate from the designated state. If your U.S. co-trustee is merely nominal and all real decisions flow from your office in Puerto Rico, the substance may not hold up.

Maintain trust assets in U.S.-state accounts. Keeping financial accounts with institutions in the designated state supports in rem jurisdiction for that state’s courts.

Consider trust registration. Some U.S. states allow voluntary trust registration, which can provide an additional basis for continuing supervisory jurisdiction.

Avoid sole trusteeship. If you are a PR resident and the sole trustee, the trust’s principal place of administration is wherever you are. Appointing a co-trustee in the designated state prevents this problem.

Review the trust for automatic migration clauses. The Treasury Regulations treat a trust as failing the safe harbor if it has a provision that would move administration outside the U.S. upon certain triggers (such as a change in law or an IRS audit). If your trust has such a clause, it should be reviewed.

What You Should Do Now

If you are an Act 60 decree holder with a revocable trust, you should evaluate your trust’s IRS classification risk. Start by asking these questions:

Who is the trustee and where are they located? If the answer is “me, in Puerto Rico,” you have a potential Court Test problem.

Where does trust administration actually take place? If it is happening in Puerto Rico, the trust’s principal place of administration may have shifted.

Where are the trust’s assets held? If they have migrated to PR-based accounts, another contact point has moved.

Does the trust have an automatic migration clause? If so, it may fall outside the Treasury Regulation safe harbor.

If the answers to these questions suggest that your trust’s real contacts have migrated to Puerto Rico, structural adjustments—such as appointing a U.S.-state institutional co-trustee, moving administration back to the designated state, or creating a complementary trust structure—may be necessary to protect your trust’s domestic classification.

This is an area where the interaction between Puerto Rico law, U.S. state trust law, and the Internal Revenue Code creates real complexity. It is worth getting it right. As of 2026, no new IRS rules or court decisions have altered the two-pronged test or its application, and the Treasury Regulation definitions remain in effect.

Hans Riefkohl is an attorney at Riefkohl Law in San Juan, Puerto Rico, focusing on trusts, estate planning, and Act 60 advisory services.