Employee Benefit Trusts With US-Citizen Participants: Which System Taxes You First

If a US citizen sits in the beneficial class of a UK employee benefit trust, the first US question is not whether the trust is a grantor or a non-grantor trust. Where the EBT is a funded, non-exempt employees' trust, IRC §402(b)(3) has already answered that: a beneficiary of such a trust is not treated as the owner of any part of it under the grantor trust rules. The analysis runs through the compensation provisions — §402(b) and, through it, §83 — and the UK side runs on an entirely separate trigger, the Part 7A "relevant step", which can bite before anything is paid at all.

That ordering is the whole article. UK commentary on EBTs is written for UK employers and says nothing about a US participant; US commentary on §402(b) is written about pensions and SIPPs. Where the two halves do meet, the US side tends to open with the family-trust fork — grantor or non-grantor — which for an EBT participant is the wrong first question.

Key takeaways

An EBT is not an EOT. An employee ownership trust is a statutory vehicle for selling a controlling interest to employees, covered in selling to an employee ownership trust as a US citizen. An EBT is a discretionary trust that warehouses shares or provides benefits. Nothing here is about a sale.
The UK charge can arrive before any money moves. Part 7A ITEPA 2003 taxes the value of a "relevant step", and earmarking — "however informally" — is itself a step.
The US charge runs through §402(b), which routes through §83, with one critical substitution: the value measured is the employee's interest in the trust, not the market value of the underlying shares.
§402(b)(3) removes the grantor-trust question as to the participant, where the subsection applies — changing what you file as well as what you pay.
The §409A carve-out that matters is not the broad-based foreign retirement plan one. It is the §83 / §402(b) property rule in the regulations.
Form 3520's instructions carry an exception for transfers to funded nonqualified deferred compensation arrangements described in §402(b) — drafted for transactions, which is narrower than "you never file".

Every one of these turns on how the trust is constituted and what the trustee actually did, not on the label on the deed.

What a UK employee benefit trust is

An EBT is a discretionary trust, usually established by an employing company, with a wide beneficial class — employees, former employees, often their families — and a trustee holding broad powers. In practice it does one of two jobs: it warehouses shares so a share plan has something to deliver when options are exercised, or it provides benefits out of funds the company has contributed. The trustee is frequently offshore, which changes the trustee's own position and does very little to the employees' UK exposure.

The structural point that matters for a US participant is that nobody is entitled to anything. That is precisely why the UK built a regime that does not wait for entitlement.

The UK side: Part 7A and the relevant step

Part 7A of ITEPA 2003, the disguised remuneration code, is deliberately broad. Section 554A switches it on where an employee is covered by an arrangement, where "it is reasonable to suppose that, in essence" the arrangement is a means of providing "rewards or recognition or loans" in connection with the employment, and where a relevant step is taken by a relevant third person.

The two steps that matter for an EBT are:

Earmarking, under section 554B. A step is taken where a sum or asset held by the trustee is "earmarked (however informally)" with a view to a later relevant step. The section then goes further: it does not matter if the details have not been worked out, if the condition "might never be met", or if the employee "has no legal right" to have anything done at all. This is the single most-repeated point in UK practitioner commentary, and it is statutory rather than a matter of HMRC practice.
Payment or transfer, under section 554C. Paying a sum, transferring an asset, releasing or writing off a loan, or making an asset available as security are each steps. "Relevant person" means the employee or a person chosen by the employee, or within a class the employee chooses.

Section 554Z2 is the charge: the value of the relevant step counts as employment income for the tax year the step is taken. It applies instead of the benefits code and instead of the ITTOIA loan provisions, so the familiar beneficial-loan machinery is displaced rather than layered on. HMRC's own guidance on the regime sits in the Employment Income Manual at EIM45000.

Loans made out of EBTs are the most litigated corner of this area, and the UK's loan charge remains the subject of ongoing litigation and review. We state the statutory mechanism and stop there; it is not our place, in a public article, to characterise outcomes or predict how any particular arrangement resolves.

The employer's deduction follows the employee's charge

Companies often assume a contribution to an EBT is deductible when made. It is not. CTA 2009 section 1290 defers the deduction until qualifying benefits are provided out of the contributions — in the period, or within 9 months of its end — with anything disallowed picked up in a later period when benefits are provided. Two outer limits apply: no deduction at all for a period of account starting more than 5 years after the end of the period in which the contributions were made, and, where the benefits give rise to both an employment income tax charge and an NIC charge, the amount qualifies only if those charges are paid within 12 months of the end of the period. Section 1292 defines what "qualifying benefits are provided" means, and its first condition is that the payment or transfer gives rise to both of those charges.

The practical consequence: the company's UK relief is built to arrive at the moment the employee is taxed.

Inheritance tax, briefly

An EBT satisfying IHTA 1984 section 86 — broadly, a class defined by employment with the body concerned, comprising all or most of its employees — sits outside the relevant property regime, because section 58(1)(b) excludes section 86 property from that definition. That is a real difference from a family settlement. In exchange, section 72 imposes its own charge where property ceases to be held on those trusts, where a payment is made for the benefit of certain people connected with the company, or where the trustees make a value-shifting disposition. Whether your trust is inside section 86 at all is a drafting question to check, not assume.

The US side: start at §402(b), not at the grantor fork

From the US, the EBT is a foreign trust, and the reflex is to ask whether it is a foreign grantor or a foreign non-grantor trust — the way every article about a family settlement is organised, ours included, in settlor-interested UK trusts and US grantor status.

For a §402(b) trust that question is closed by statute. §402(b)(3) provides that a beneficiary of such a trust "shall not be considered the owner of any portion of such trust" under the grantor trust rules. Where the subsection applies, the participant is not a grantor-trust owner of the EBT, and the consequences run straight into the reporting below. Note the limits: it says nothing about the employer's position, and nothing about a trust outside §402(b)(1).

What §402(b)(1) actually measures

This is the detail that produces wrong numbers. §402(b)(1) includes employer contributions to a non-exempt employees' trust in the employee's income "in accordance with section 83" — but with an express substitution: the value of the employee's interest in the trust is used in place of the fair market value of the property.

So §83 supplies the timing — income arises at the first time the rights are transferable or not subject to a substantial risk of forfeiture, whichever is earlier — while §402(b)(1) changes the object being valued. For an EBT holding shares, the thing measured is the participant's interest in the trust, which is not the same as a block of shares, and in a discretionary trust may be a genuinely difficult valuation. The §83(b) election, which accelerates the charge to the time of transfer, has to be made not later than 30 days after the transfer and cannot be revoked without consent; it is also irreversible in the unhelpful direction, because a later forfeiture produces no deduction.

Distributions are then dealt with under §402(b)(2), which taxes amounts "actually distributed or made available" under the §72 annuity rules. The words "or made available" matter: availability, not receipt, can be the trigger.

There is a separate annual charge in §402(b)(4) for a highly compensated employee, measured on the vested accrued benefit at the close of the trust's year rather than on contributions or distributions, where the plan fails the §401(a)(26) or §410(b) coverage tests. Whether a participant falls inside that definition is a §414(q) question to work through with figures in front of you.

One escape route that readers expect does not open. §402(d) treats a foreign trust as exempt where it is a "stock bonus, pension, or profit-sharing trust" that would qualify under §501(a) but for being organised outside the United States. A wide-discretion employee benefit trust is not one of those three things, and would not qualify under §501(a) in any event.

The §409A question, answered on the right provision

Every cross-border §409A article discusses the "broad-based foreign retirement plan" exclusion. For an EBT that is a dead end: the regulation requires a wide range of covered employees "substantially all of whom are nonresident aliens", plus restrictions that discourage access before retirement. A corporate EBT meets neither.

The provision that does the work is Treas. Reg. §1.409A-1(b)(6)(i). It treats a transfer of property as including "the transfer of a beneficial interest in a trust ... to the extent such a transfer is subject to section 83, section 402(b) or section 403(c)", and it adds that a right to income required to be included under §402(b)(4)(A) "is not a deferral of compensation". In other words, where the arrangement is genuinely inside the §83 / §402(b) property world, §409A's deferral concept does not reach it. Where it is a bare promise to pay later, it may. Which of those you have is a drafting question, and it is the one worth asking early.

Reporting: narrower than you have been told

The Instructions for Form 3520 open their "Exceptions To Filing" list with transfers to funded nonqualified deferred compensation arrangements described in §402(b), to §404(a)(4) foreign trusts, and to amounts under a §404A qualified foreign plan. Read the framing carefully: the instructions say Form 3520 does not have to be filed "to report the following transactions", and the bullet names transfers. It is an exception for particular transactions, not a declaration that no part of Form 3520 can ever touch someone connected with such an arrangement.

Two further points follow from the same instructions. The "treated as having a U.S. beneficiary" machinery expressly excludes a deferred compensation trust described in §6048(a)(3)(B)(ii), so the presumption that catches family settlements is switched off here. And Form 3520-A is the annual return of a foreign trust with a US owner — which, given §402(b)(3), is the exact status the participant does not have. The IRS's foreign trust reporting page sets out the wider framework, and our explainer on foreign trusts and Form 3520 for US persons in the UK covers the default rules this departs from.

None of that disturbs FBAR, Form 8938, or the income tax itself. Reporting relief is not tax relief, and the two are routinely confused.

Where the two systems collide

Put the triggers side by side and the problem is obvious. The UK can charge on an earmarking that confers no legal right and may never pay out. The US charges when rights become transferable or stop being subject to a substantial risk of forfeiture, measured on an interest in a trust. Those are different events, in different tax years, on different valuations, under calendars that do not align. A foreign tax credit relieves foreign tax actually imposed and paid or accrued, so where the two charges land in different years the credit can fail on timing even though the same economic value is taxed twice. That is the real cost of an EBT with an American in the class, and it is why the position is worth modelling before the trustee does anything.

What to do

Get the deed and the trustee's actual conduct, not a summary. Whether anything has been earmarked is a question of fact, and informal is enough.
Establish whether the trust is within §402(b)(1) at all. Everything above turns on it, including whether §402(b)(3) is available.
Value the right object. The interest in the trust, not the underlying shares.
Diarise the §83(b) window before any transfer, because it cannot be rescued afterwards.
Test the §409A position on the property provision, not on the retirement-plan exclusion.
Map the UK and US trigger dates onto the same timeline and see whether the credit survives the mismatch.

How we work on these

We are usually brought in alongside a company's existing UK advisers to own the US side of a trust designed without one in mind: establishing whether §402(b) applies, valuing the interest rather than the asset, working out what is genuinely reportable, and putting the UK and US trigger dates on one timeline so the credit position is visible before it is lost. Cross-border trust positions go to a licensed professional for review by default — a CPA or Enrolled Agent reviews and signs every US filing, and an ACCA-qualified accountant reviews the UK side.

Our US-UK private client tax service sets out the engagement and our pricing is published in full. If an EBT has an American in the beneficial class, book a confidential consultation before the trustee takes a step rather than after.

This article is general information, not tax or legal advice, and does not create a professional relationship. It is not a recommendation to pursue or avoid any particular structure. Outcomes are highly fact-dependent and the rules change — confirm the current position with a licensed professional before acting.

Reviewed by a CPA / Enrolled Agent. Last updated: 9 November 2026.

Frequently asked questions

How are payments to beneficiaries from an employee benefit trust taxed?+

On the UK side, ITEPA 2003 section 554Z2 treats the value of a “relevant step” as employment income for the tax year the step is taken, and it applies instead of the benefits code and instead of the ITTOIA loan provisions rather than alongside them. Paying a sum, transferring an asset, releasing a loan or making an asset available as security are each steps under section 554C, and “relevant person” extends to someone the employee chooses. For a US participant the analysis is separate: where the trust is a funded non-exempt employees’ trust, IRC §402(b)(2) taxes amounts actually distributed “or made available” under the §72 annuity rules, so availability can be the trigger rather than receipt. The two charges do not necessarily arise in the same year, which is where foreign tax credit problems begin.

Is a UK employee benefit trust a foreign trust for US tax purposes?+

Yes — a UK EBT is a foreign trust seen from the United States. But the usual next question, whether it is a foreign grantor or a foreign non-grantor trust as to the participant, is answered by statute where the trust is within IRC §402(b)(1). §402(b)(3) provides that a beneficiary of such a trust “shall not be considered the owner of any portion of such trust” under the grantor trust rules. That is a narrow provision: it speaks to the beneficiary, not the employer, and only where §402(b)(1) applies. Establishing whether it does is the first piece of work, not an assumption.

Do I have to file Form 3520 for an employee benefit trust?+

The Instructions for Form 3520 open their “Exceptions To Filing” list with transfers to funded nonqualified deferred compensation arrangements described in §402(b), trusts described in §404(a)(4), and amounts under a §404A qualified foreign plan. Read it precisely: the instructions say Form 3520 does not have to be filed to report the following transactions, and the bullet names transfers. It is an exception for particular transactions, not a blanket statement that the form can never apply. Form 3520-A is the annual return of a foreign trust with a US owner, which §402(b)(3) says the participant is not. None of this affects FBAR, Form 8938, or the income tax itself — reporting relief is not tax relief.

Am I taxed when shares are earmarked for me, or only when I actually receive them?+

Under UK law, earmarking is itself enough. ITEPA 2003 section 554B catches a sum or asset earmarked “however informally” with a view to a later relevant step, and the section expressly says it does not matter that the details have not been worked out, that a condition might never be met, or that the employee has no legal right to have anything done. The US timing is different: §402(b)(1) includes amounts in accordance with §83, so income generally arises at the first time rights are transferable or no longer subject to a substantial risk of forfeiture. A §83(b) election accelerates that to the time of transfer but must be made not later than 30 days after it, and a later forfeiture produces no deduction.

Does section 409A apply to a UK employee benefit trust?+

Possibly, but the provision usually quoted is the wrong one. Cross-border §409A commentary focuses on the “broad-based foreign retirement plan” exclusion, which requires a wide range of covered employees “substantially all of whom are nonresident aliens” and restrictions discouraging pre-retirement access — conditions a corporate EBT cannot meet. The relevant rule is Treas. Reg. §1.409A-1(b)(6)(i), which treats a transfer of a beneficial interest in a trust as a transfer of property to the extent it is subject to §83, §402(b) or §403(c), and states that a right to income under §402(b)(4)(A) is not a deferral of compensation. Whether your arrangement sits inside that property world or is a bare promise to pay later is a drafting question worth settling early.