In which state your trust “lives” — including your grantor, trustee, administration and even perhaps your beneficiary — will determine how the trust will be taxed. Residency status also helps identify what planning opportunities may be available to minimize the tax.
Each state has its own method to determine if the trust is a resident or nonresident of the state, but below are some of the common factors a state will consider:
This is the most common factor used to determine residency, and the only one that cannot be changed after the trust is established. The state will look to where the grantor resided at the time the trust was established, for intervivos trusts, and where the testator resided for testamentary trusts. Residency of the grantor can also be determined by the grantor’s residency when the trust becomes irrevocable.
To meet this requirement, at least one fiduciary must reside in the state to qualify the trust as a resident. In certain states, if there are multiple fiduciaries, some of which are residents and others non-residents, the trust may be required to apportion its income. This factor may also be combined with other factors, such as the residency of the grantor or the location of the trust administration.
Some states use the location of the management or administration of the trust to determine its residency. This factor may also be combined with others, such as the residency of the grantor and the residency of the trustee.
There are a few states that look to the residence of the beneficiary of a trust to determine its residence. The states that use this factor also tend to use either the residency of the grantor or the residence of the trustee, too. In certain states there may also be a minimum time limit that must be met to determine if the beneficiary is a resident of a certain state. This factor gains importance as distributions begin to be made from the trust.
There are a few states where the type of trust could change the residency factors. One common difference is determining the residency of the grantor.
Each state has its own specific requirements, but once a trust determines its status in a specific state, it can determine where it has taxable income. In a resident state, generally all trust income is taxed. In states where a trust is a non-resident, only the portion of income sourced to that state will be taxed.
As an example, in Ohio the driving factor to determine the residency of a trust is the residency of the grantor and/or the decedent. Consider the following scenarios.
A trust created at death is known as a testamentary trust. The residence of the trust is then determined by looking to where the testator of the testamentary trust was domiciled for estate tax purposes. If the testator was located in Ohio, the testamentary trust has Ohio residency. Ohio does not require that the trustee or beneficiary be a resident for the trust to be considered an Ohio resident.
Ohio looks to where the transferor was domiciled at the time the property was transferred to the irrevocable trust. The state also requires that for some portion of the taxable year at least one qualifying beneficiary is domiciled in Ohio. A qualified beneficiary includes any potential current beneficiary other than those that fall under Internal Revenue Code Section 170. In this scenario, the domicile of the transferor when the trust became irrevocable doesn’t apply, and the transferor of the property doesn’t have to be the creator of the trust.
A trust is considered an Ohio trust when the trust document becomes irrevocable, the transferor of the property was domiciled in Ohio for Ohio individual income tax purposes, and for some portion of the taxable year at least one qualifying beneficiary is domiciled to Ohio. In this scenario, the transferor’s domicile when the property was actually transferred does not apply, only the domicile when the trust becomes irrevocable is considered. In addition, the transferor does not need to be the creator of the trust.
When planning for a new trust, its residency should be a topic of conversation. To the extent possible, consider establishing a trust in a favorable location, such as a state without an income tax. Although distributions from a trust to a beneficiary would typically be taxable to the beneficiary's state of residency, income retained in the trust could benefit from the favorable tax jurisdiction.
It’s also important to consider the other relevant trust residency factors to help minimize tax. For example, in situations where the location of the trust administrator is a factor, consider moving the administration out of state. In states that look at the residency of the trustee and/or beneficiary, consider changing the trustee and/or encouraging both the trustee and beneficiary to move into a more tax-favorable state. With 50 states, the possibilities are too voluminous to discuss in their entirety here, but an awareness of the issue is the first step in further discussions with your tax advisor.
Please contact Laura Sefcik at lsefcik@cohencpa.com or a member of your service team for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.