How trust income tax works across state lines

Beneficiary residence and the limits of Kaestner

In Kaestner, beneficiary residence alone did not justify North Carolina's tax on undistributed trust income under the specific facts before the Court.

The beneficiaries received no trust income during the relevant tax years. They could not demand income or control, possess or enjoy trust assets, and could not count on receiving a specific amount in the future.

The holding is limited to those facts. It does not establish a general exemption for trusts with resident beneficiaries.

California separates income source from residence

In California, retained trust income from California sources is taxable regardless of fiduciary or beneficiary residence.

For income from other sources retained by the trust and allocated to principal, taxation depends on fiduciary and noncontingent beneficiary residence. A noncontingent beneficiary has an unconditional interest in trust income or corpus.

Contingent beneficiaries are excluded from that determination. When a trust has resident and nonresident trustees and resident and nonresident noncontingent beneficiaries, Schedule G apportionment applies.

New York residence and the separate exemption

In New York, a trust created by the will of a person domiciled there at death is a resident trust. An irrevocable trust holding property transferred by a person domiciled there at transfer is also resident.

For a formerly revocable trust, the relevant domicile is the property contributor's domicile when the trust became irrevocable. Fiduciary residence does not change the trust's resident classification.

A New York resident trust is exempt from state personal income tax only when all three conditions below are met:

• All trustees are domiciled in another state.
• The entire trust corpus, including real and tangible personal property, is outside New York.
• All income and gains come from or are connected with sources outside New York, determined as for a nonresident trust.

The department treats intangibles located in New York as outside the state if they are not employed in a business there. Selling an interest in an entity owning New York real property may produce New York source income.

A resident trust meeting the exemption conditions must still file Form IT-205 with Form IT-205-C annually.

Accumulated income distributed to a resident beneficiary

The exempt resident trust instructions require Form IT-205-J when the trust reports an accumulation distribution to a New York resident beneficiary.

For this purpose, exclude income currently required to be distributed from amounts properly paid, credited or required to be distributed. The remaining amount must exceed DNI reduced by currently required income distributions.

The distribution must also exceed trust accounting income. Income earned in a tax year before the beneficiary's birth or attainment of age 21 creates no New York accumulation distribution and requires no Form IT-205-J.

Pennsylvania distributions and income source

Pennsylvania resident beneficiaries report estate or trust income received or credited on Form PA-40. Nonresident beneficiaries report such income from Pennsylvania sources.

The income retains its source character even though it does not retain its original classification in the beneficiary's hands.

Pennsylvania's distribution deduction considers both total DNI and Pennsylvania source DNI. Governing instrument provisions control when they specifically identify accounting income amounts and the sources for distributions, permanent set asides or uses.

Otherwise, applicable DNI limits the deduction. Provisions fundamentally departing from local law concepts primarily for tax avoidance are disregarded.

No deduction is allowed for a specific property or money bequest if the beneficiary is not taxable on it under the distribution rules.

Two related terms

An Investor Advantage perspective

A participant describes the experience of working between different systems, a useful perspective to bring to a conversation involving several states.

"our focus is always started from the defense perspective. taxes, asset protection, estate planning. That always drove everything. But really, over time, what's what what's happened for us is that we've become the converter between various systems."

Common questions