Governing Law Does Not Determine A Trust’s State Income Tax Liability

While it is well-established that if a trustee wants to know what law governs the trust he or she should look to the choice of law provision in the applicable trust instrument. However, if the trustee wants to know whether the trust must pay a state income tax on the ordinary and capital gains earned on the principal of the trust, the trustee must look to a few different factors. In particular, a trustee might want to answer the following questions because these are crucial to determining whether he must pay a state income tax.

1. “Where does the testator reside?”
2. “Where does the [settlor] reside?”
3. “Where will the trustee administer the trust?”
4. “Where does the trustee reside?”
5. “Where do current and future beneficiaries reside?”

It is important to note that there are also a few states that follow the governing law of the trust, such as Louisiana, Idaho, and North Dakota.

See Richard W. Nenno, Governing Law Matters Not When Assessing Whether a Trustee Must Pay a State’s Income Tax, Bloomberg, BNA, Nov. 9, 2012.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.