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Tax Requirements for Trusts

Posted on: July 10th, 2014
trust taxesDo you need to pay income tax on a trust? Every state has different laws regarding whether a trust is taxable in that state. The following post reviews current laws regarding trust taxation in North Carolina and other states our firm serves, although careful review of each state’s tax laws is recommended to determine whether trust income is taxable in a particular state. 

In many states, an important factor in determining whether the trust is taxable is where the beneficiaries, settlor, and trustees are domiciled. A tax attorney knowledgeable in trust taxation can help you to determine how trust assets might need to be structured with respect to each state’s tax laws to achieve the most favorable tax treatment.

As with any estate planning matter, annual reviews can help to effectively address legislation changes. With advanced planning and the right tools, individuals can preserve their intentions for asset distribution.

North Carolina Taxes on Trusts

Income tax must be paid on trusts that meet the requirements below, according to the North Carolina Department of Revenue. First, the trust must be required to file a federal return on the income earned by the trust.  In addition, the trust must either:
  1. Derive income from North Carolina sources or
  2. Derive any income which is for the benefit of a resident of North Carolina.

The D-407 must be filed by April 15th for trusts on a calendar year basis, or by the 15th of the fourth month after the end of the fiscal year if on a fiscal year basis.

Tennessee Taxes on Trusts

According to the Tennessee Department of Revenue, individuals who are trustees, guardians or administrators of trusts must pay income tax if:
[They] received more than $1,250 in taxable interest and dividend income for the benefit of Tennessee residents. 

Trustees who are receiving taxable income on behalf of NONRESIDENT BENEFICIARIES are NOT required to file a return. However, when taxable income is received on behalf of both RESIDENT and NONRESIDENT BENEFICIARIES, ONLY THE TAXABLE INCOME OF ANY RESIDENT BENEFICIARY is required to be reported in Schedule A…Nonresident income may be reported in Schedule B…A trust is entitled to only one exemption of $1,250, regardless of the number of beneficiaries.

Beneficiaries will need to satisfy income tax requirements as follows:
The trustee shall report to each resident beneficiary the amount of taxable income distributed to him, and the beneficiary shall be liable for the tax. 

Trustees of Charitable Remainder Trusts do not pay income tax. Read more tax requirements on trusts in Tennessee.

Florida Taxes on Trusts

Florida has no state income tax. Florida also does not impose estate, gift, or Generation Skipping Transfer taxes. When it comes to real property in Florida held in trust, the holding in Taylor v. State Tax Commission governs.  According to the National Association of Estate Planners and Councils, “in Taylor v. State Tax Commission…the state of New York attempted to apply its income tax on the gain incurred upon sale of Florida real property held in a trust created under the will of a New York decedent. The trustees were not New York residents. The court held that, since the domicile of the decedent was the only New York connection to this transaction, the state could not impose tax on the gain.” 

New York Taxes on Trusts

Tax must be paid for resident trusts that meet one of the following requirements:
  1. Required to file a federal income tax return for the tax year
  2. Had any New York taxable income for the tax year
  3. Had tax preference items for minimum income tax purposes in excess of the specific deduction or
  4. Subject to a separate tax on lump-sum distributions

Tax must be paid for non-resident trusts that meet one of the following requirements
  1. Had income derived from New York State sources and had New York adjusted gross income
  2. Had tax preference items for minimum income tax purposes derived from or connected with New York State sources in excess of the specific deduction
  3. Subject to a separate tax on lump-sum distributions or
  4. Incurred a net operating loss for New York State income tax purposes for the tax year without incurring a net operating loss for federal income tax purposes

Recent changes to legislation now regulate the use of out-of-state trusts created by New York residents. Under the new law, beginning with income earned after January 1, 2014, non-grantor trusts set up by New York resident grantors are taxed when distributions of accumulated income are made to New York resident beneficiaries.  The new tax will not apply to distributions of accumulated income to New York beneficiaries that are made prior to June 1, 2014.  Out-of-state trusts are attractive for New Yorkers as these tools help minimize income tax, capital gains tax in some situations, and estate tax—which has recently made headlines due to the new “New York estate tax cliff.” Read more about a NY tax law affecting trusts.
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