Roger Russell for OnWallSreet.com writes: In the world of trust and estate administration, where tax planning
typically involves special attention to federal tax law compliance, it’s
easy to lose focus on state income taxation issues. And while some states do not tax income related to trusts, states
that do tax trust income have a variety of rules and criteria for which
trusts are subject to tax.
Since CPAs can enter the picture both
as trust advisors and as trustees, and as preparers of the trust income
tax return, they need to be aware of what characteristics may result in a
trust being subject to a state’s income tax, according to Christine
Albright, a partner with Holland & Knight. “Part of the
problem we’re faced with is that the 51 jurisdictions that we’re dealing
with don’t play by the same rules,” she said.
“Some have no
income tax at all, some base their tax on where the person who created
the trust resided at the time the trust was created or at the time it
became irrevocable, others look to the state where the trust is being
administered, or where a trustee resides, or where a beneficiary
reside,” said Albright. “Depending on the answer to these types of
questions, different states take the position that they have nexus over
the trust, and if they have that, then they can tax some portion or all
of the income.”
An example of the complexity of the issue is when a trustee changes
residency to a different state, Albright noted. “In some situations a
trustee’s move has the potential to trigger state income tax on the
trust in the new state in which the trustee now resides,” she said. “But
often the impact of such a move may not be understood and therefore go
unreported for a number of years. This in turn could result not just in
unpaid taxes, but the resulting interest and penalties.”
And
things can change over time, creating a trap for the unwary, Albright
observed. “For example, I live in Florida and set up a trust in Florida
for my children, who also live in Florida. But I name my brother-in-law
or best friend who happens to reside in Georgia, California, Arizona,
Kentucky, New Mexico, North Dakota, Oregon or Virginia as the trustee.
And based on the fact that the trustee lives in one of those states, all
of a sudden the trust is subject to tax in one of those states.”
To
complicate matters further, the state where a trust is taxable can move
based on where the trustee resides, where the beneficiaries reside, or
where the trust is administered. “There could be a trustee in Georgia
and one in Arizona, and you may be taxed in both states,” she said. “The
existence of a credit [for taxes paid to another state] is determined
on a state by state basis, and very often, even with the credit, you
might end up paying more than if you weren’t taxed in multiple states.”
Albright believes that many states are not aware that a trustee resides in the state, making the trust taxable in the state.
“How
would, say, California or Arizona know that someone who moves to their
state is a trustee?” she said. “The trustees don’t know they have to
file, and the state has no reason to know.” There could be a
problem for successor trustees who take over for someone who rendered
the trust liable for tax but did not file. “They have to understand that
they may be getting the trust in further trouble with interest and
penalties if they find out and do nothing,” she cautioned. “Clients,
beneficiaries and trustees don’t stay where we put them. For accountants
preparing income tax returns, every year, I worry whether they realize
that a trustee might have retired and moved to Arizona.”
“Even
with a small trust, if a beneficiary moves to the wrong state, it can
trigger tax liability that the accountant just doesn’t think of,” she
said. “They have blinders and are focused on their own state rules
rather than tracking where all the other possible triggers are located.”
Albright
recommends that a trustee should arrange for periodic reviews of the
trust regarding various state income tax laws, and develop a system for
tracking state requirements as well as other factors that could trigger
state income taxes.
Friday, March 22, 2013
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