Article on California Income Taxation of Trusts and Estates

Richard S. Kinyon (Shartsis Friese LLP), Kim Marois (Clement, Fitzpatrick & Kenworthy, Inc.) Sonja K. Johnson (Anderson Yazdi Hwang Minton + Horn LLP) recently published an article entitled, California Income Taxation of Trusts and Estates, 39 ACTEC Law Journal No. 1 & 2 (Spring/Fall 2013).  Provided below is an excerpt from the article:

California’s income taxation of trusts has unpleasantly surprised many trust fiduciaries and beneficiaries. Its unique method of taxation, based on the residence of the trust’s fiduciaries and beneficiaries (and regardless of the residence of the settlor), may affect trustees and beneficiaries (as well as their lawyers and other advisors) far beyond the California borders.

For example, consider an irrevocable, non-grantor trust1 established by an Illinois resident that is administered by two co-trustees, one of whom is an Illinois resident and the other of whom is a California resident. All beneficiaries of the trust also reside in Illinois. Despite the predominately non-California connections, and even if the Illinois cotrustee is more actively involved in the administration of the trust, half of the trust’s undistributed net income is currently taxable by California.

Alternatively, consider another irrevocable, non-grantor trust, this time with a New York settlor. In this case, the trust is administered in New York by a New York resident serving as the sole trustee. However, the trust’s sole beneficiary is a California resident with a vested (i.e., non-contingent) interest in the trust property. Despite the trust’s New York origin and administration, all of the trust’s undistributed net income is currently taxable by California.