The Supreme Court of California (the Supreme Court) has confirmed an appellate court’s ruling that a trust must pay California income tax on all California-sourced income earned by the trust, regardless of whether the trust fiduciaries or beneficiaries reside in California.
The case concerned the Paula Trust, which had sold an interest in a business that operated in California. One of its two trustees resided out-of-state, and the trust argued that this implied that only half of the income from the sale was taxable in California.
Against this, the California Franchise Tax Board (FTB) cited its long-standing regulations stating that a trust is taxable on 100 per cent of its California-sourced income, including income earned from a business carried on in California and the sale of real or tangible property located in the state. It is also taxable on a portion of its non-California-sourced income, based on the state of residence of the fiduciaries and the non-contingent beneficiaries of the trust.
The original trial court rejected the FTB’s position, ruling that its non-resident individual sourcing rules did not apply to trusts, and that the residence of the trust’s fiduciaries and non-contingent beneficiaries is the only basis for taxing the trust’s income. The FTB could therefore tax only half of the trust’s income from the sale of the business.
That decision has now been overturned on appeal. The appellate court upheld the validity of the FTB’s regulations, requiring taxation of all of a trust’s California-sourced income. Only income derived outside California based on the residence of the fiduciaries and non-contingent beneficiaries was subject to apportionment, it ruled.
The trust petitioned the Supreme Court to overturn the appellate court’s decision, but the petition was denied and the appellate court ruling stands.
The outcome is disappointing for non-grantor trusts with non-California fiduciaries and non-contingent beneficiaries, said tax experts at law firm Venable, pointing to the fact that California’s 13.3 per cent state income tax rate is the highest in the US and could soon be increased to 16.8 per cent.
“Planning to save state and local income taxes will remain an important tax and estate planning consideration, especially since the 2017 Tax Cuts and Jobs Act caps the deduction for state and local taxes at USD10,000 per year”, said the firm. “Establishing a properly structured non-grantor trust in a low- or no-income tax state and transferring the assets to such trust can generate significant state income tax savings.”
News Source：【STEP 2020/10/22】