On January 19, 2010, a Bill was introduced to the New York State Assembly to amend the manner in which "resident trusts" are taxed in New York. The Bill seeks to repeal the existing statutory framework that enables a resident trust to avoid New York income tax and to adopt, in lieu thereof, a much more narrow exception applicable only to inter vivos resident trusts having no New York beneficiaries and no New York source income. If enacted, planning around the New York income tax will become a much greater challenge.
In general, New York imposes an income tax on the income (regardless of source) of any trust that is a resident trust.
The definition of a resident trust is set by statute. Specifically, a resident trust means (1) a trust established under the Will of a decedent who at his or her death was domiciled in New York, (2) a trust (whether irrevocable or revocable) established by a person who was domiciled in New York at the time of the trust's creation or (3) a revocable trust that later became irrevocable while the settlor was domiciled in New York.
Not all resident trusts are subject to New York income tax, however. In fact, if certain requirements are met, a resident trust may avoid New York income tax altogether. The three requirements that must be satisfied to do this are:
- All of the trustees must be domiciled in a state other than New York;
- The entire corpus of the trust, including real and tangible personal property, must be located outside of New York; and
- All income and gains of the trust must be derived from or connected with sources outside of New York.
Intangible property is not considered to be located inside of New York as long as none of the trustees is domiciled in New York. Additionally, the income from intangible property is not treated as New York source income as long as the property is not employed in or derived from a New York business.
Accordingly, under existing law, New York will not impose an income tax on a resident trust if there are no New York trustees, there is no real or personal property located in New York and there is no New York source income. However, all of these requirements must be met for the avoidance of tax. The failure of the resident trust to adhere to any one condition (e.g., the trust generates $1 of New York source income) will cause the resident trust to be fully taxable.
Given this statutory framework, taxpayers have been able to structure trusts that escape New York income tax.
Under the Bill, the statutory provision setting forth the three requirements that allow a resident trust to avoid New York income tax is repealed. The Bill then fashions a new, much more circumscribed exception to the New York income tax for certain inter vivos resident trusts.
The effects of the Bill would be as follows:
- Any testamentary trust established under the Will of a decedent who at his or her death was domiciled in New York would be fully taxable, without exception; and
- Any inter vivos trust (being either an irrevocable or revocable trust established by a person who was domiciled in New York at the time of the trust's creation or a revocable trust that later became irrevocable while the settlor was domiciled in New York) would be fully taxable, unless (a) there are one or more nonresident "ascertainable beneficiaries" and (b) there is no income derived from or connected with New York sources.
The Bill defines an "ascertainable beneficiary" as a currently living ascertainable beneficiary who has a present or future interest in the trust, including a beneficiary whose interest has not yet vested (e.g., a trust remainderman).
As a result, if enacted, the only resident trusts that could possibly avoid New York income tax would be those created during lifetime by a New York settlor having no present or future beneficiaries residing in New York and no New York source income. The domicile of the trustees would no longer be a factor in determining a resident trust's tax liability.
As to those non-testamentary resident trusts with one or more nonresident ascertainable beneficiaries but no income derived from or connected with New York sources, the New York taxable income is based on a fractional share of ascertainable beneficiaries who are New York residents. For example, if one-half of the beneficiaries are New York residents, one-half of the non-New York source income is taxable by New York.
The Bill also provides that if a beneficiary of a resident trust is a partnership, limited liability company or S corporation for which an election has been made under applicable New York law, the trust shall, for purposes of determining the number of ascertainable beneficiaries who are New York residents, count each partner, member or shareholder as a separate beneficiary and determine each of their residence separately.
Purpose of the Bill
The stated purpose of the Bill is to reduce the tax avoidance opportunities of resident trusts through the use of trustees domiciled outside of New York. As discussed above, the Bill accomplishes this by eliminating the existing tax exemption for resident trusts and replacing it with a new one, which is much more restricted.
It appears from the memorandum in support of the Bill that New York would like to align itself with other states that have taken similar taxing positions. The Bill memorandum states (1) that recent state and federal appellate decisions have upheld the constitutionality of taxing a percentage of trust income in cases where the trust settlor is a state resident according to the percentage of trust beneficiaries who are state residents and (2) that many states also tax all of the income from testamentary trusts when the decedent was domiciled in that state.
The Bill would take effect immediately and apply to taxable years beginning on or after January 1, 2010.