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Governing Law Matters Not When Assessing Whether a Trustee Must Pay a State's Income Tax

Friday, November 9, 2012

By Richard W. Nenno, Esq.

Managing Director and Trust Counsel, Wilmington Trust Company, Wilmington, DE

The attorney wishing to know how long a trust can last, whether adopted children qualify as beneficiaries, and the like quite rightly begins her analysis by consulting the provision in the governing instrument that specifies which state's law governs the trust's validity, construction, and administration, as well as the ability of creditors to reach its assets. When the planner wants to find out whether the trustee must pay a particular state's income tax on the trust's accumulated ordinary income and capital gains, however, he must suppress the urge to pin down governing law and look to other criteria. In particular, he must answer the following five questions (none of which involves governing law) because those answers, alone or together, will establish taxability in almost all cases:

  •   Where does the testator reside?
  •   Where does the trustor reside?
  •   Where will the trustee administer the trust?
  •   Where does the trustee reside?
  •   Where do current and future beneficiaries reside?

True it is that Louisiana, Idaho, and North Dakota base taxation in whole or in part on governing law. Otherwise, though, this factor rarely will come into play in determining whether a state's income tax applies.

For more information, in the Tax Management Portfolios, see Acker, 852 T.M., Income Taxation of Trusts and Estates, and in Tax Practice Series, see ¶6120, Estate and Trust Income Taxation - General Rules.

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