While we are not licensed to practice law in New York, income taxation of trusts and estates is becoming more and more important for all of our clients. We have had a number of clients who become fiduciaries for estates and trusts in New York or other states, so it is important for us to have a good understanding of the tax laws in many states. For that reason, it is important to note that for Tax Years 2012-2014, the top tax bracket for New York State nongrantor “resident trusts” is 8.82%. If that trust is in New York City, that marginal rate can increase to around 13%. Now, more than ever, it is important to explore possible steps to lower or eliminate state income taxes on irrevocable trusts, especially in high tax states like New York.
Nongrantor Trusts. By way of background, you should know that the distinction between a grantor and nongrantor trust is important, because the distinction often results in different tax rates. The IRS explains that a grantor trust is a trust “over which the grantor or other owner retains the power to control the trust’s income or assets.” Income from a grantor trust is taxable to the grantor at his or her rates in the state in which the Grantor resides (with certain exceptions for income earned from assets located in, or activities held in, other states). In New York, trusts that the IRS do not consider to be grantor trusts are classified as nongrantor trusts. These nongrantor trusts are thus separate taxpayers for both Federal income tax purposes and state income tax purposes.
Resident Trusts. Nongrantor trusts that are considered to be New York resident trusts are taxed by the state on all of their income – but there may be a way to eliminate that tax. By the way, every state has its own law as to whether a nongrantor trust is subject to income tax in that state.
For the purpose of this blog, we are going to describe what makes a trust a New York “resident trust”. First, a trust that was created by a Will of a New York resident decedent is a New York resident trust. Second, an irrevocable trust was created by an individual who is a resident of New York is a New York resident trust. Third, a revocable trust that becomes irrevocable is a New York resident trust if the person who created the trust was a New York resident at the time the trust became irrevocable..
However, even if a trust is New York resident trust, no New York income tax may be imposed if 1) no trustee is domiciled in New York; 2) the trust’s assets are not located in New York AND 3) the trust’s income and gains must come from sources outside of New York.
Therefore, avoiding New York income tax can be accomplished by eliminating all contacts with New York. The Trustee must be located outside New York. The assets have the trust must be located ourside New York. No income of the trust may be due to a activity in New York. This can be done by removing New York Trustees, by transforming tangible property into intangible property via an LLC or partnership;or, if only a portion of the trust has New York source income, splitting the trust into two, so that only one is subject to the New York income tax and the other is not.
Some states, like Delaware, do not impose an income tax on trusts where all beneficiaries are not located in Delaware. The end result is that state income tax on nongrantor trusts can be eliminated by choosing carefully the state where the trust is governed and who the Trustee is.
- Gary Altman, Esq. and Coryn Rosenstock