December 6, 2024
State Income Tax Implications for Non-Grantor Trusts
A non-grantor trust is a type of trust where the grantor, typically the person who creates the trust, relinquishes control over the trust’s terms, beneficiaries, and revocation rights. As a result, the trust is treated as a separate taxable entity, required to file its own tax return (Form 1041). Like individuals, non-grantor trusts are subject to federal and state income taxes, but the specific tax treatment depends on various factors such as trust residency, income sources, and multi-state considerations. Here’s a more holistic view of the key tax factors that can influence your trust’s obligations:
1. Trust Residency
State tax laws vary significantly when determining a trust’s residency. Where a trust is considered a resident determines which state’s laws apply for income tax purposes, and several different factors can influence this determination:
- Grantor’s Location: Some states like Illinois, Maine, Maryland, Michigan, Pennsylvania, Vermont, and Virginia consider the trust a resident if the grantor is a resident of that state.
- Trustee’s Location: Other states including Arizona, California, Montana, Oregon, and Virginia base residency on the location of the trustee or fiduciary who administers the trust.
- Beneficiary’s Location: California, Georgia, Montana, North Carolina, North Dakota, and Tennessee may consider where the beneficiaries reside.
In some cases, a trust may meet the residency criteria of multiple states due to differing definitions of residency. This can lead to a situation where your trust is subject to tax obligations in more than one jurisdiction, requiring careful consideration of each state’s tax laws.
2. Taxation of Resident Trusts
- Most states tax a trust on all its income if it is considered a resident trust, regardless of where the income is earned. This means that even if a trust generates income from outside the state, it could still be taxed by the state where the trust is a resident. For example, if a trust is a resident of New York but earns rental income from a property in another state, the trust may still be taxed by New York on that income.
- Fortunately, many states offer apportionment provisions or tax credits to mitigate this. States may allow a trust to apportion its income based on factors like the location of property or business activities, or the state may offer credits for taxes paid to other states.
- Tax Credits and Deductions: States that impose income tax on non-resident trusts may offer credits or deductions for taxes paid to other states, helping to alleviate the financial burden of double taxation.
- State-Specific Strategies: Navigating these provisions requires careful planning, as each state has its own rules on apportionment, credits, and deductions.
3. Source of Income
In addition to residency, many states tax income based on where the income is sourced, regardless of the trust’s residency. This means that if the trust owns property, conducts business, or earns income from activities in a particular state, that income may be subject to state income tax, even if the trust itself is not a resident of that state.
- Property-Related Income: Income generated from real estate or tangible assets located in a specific state may be subject to that state’s taxes, regardless of the trust’s residency.
- Business Income: If the trust operates a business or receives business-related income within a state, that income may also be taxed by that state, even if the trust itself is considered a resident elsewhere.
Conclusion
State income taxes for non-grantor trusts can be very complicated, requiring careful attention to residency, sourcing rules, and multi-state taxation. At GO, we are committed to providing not just compliance but proactive, holistic tax planning strategies. Our team of experienced professionals is here to guide you through the complexities of fiduciary taxation, helping you minimize tax liabilities and adapt to changes in the law and your personal circumstances.
Please feel free to reach out to your designated GO contact to explore the most efficient approach to managing your trust’s state income tax obligations, while aligning with your broader financial and estate planning goals.
Writer: Diem Bui, CPA, EA, MBA – Tax Manager
References
https://www.thetaxadviser.com/issues/2021/may/trust-state-tax.html