The New York State Bar Association Tax Section released a report November 18th which outlined its continued disapproval of a 2010 proposal to eliminate the income tax exemption for non-grantor resident trusts, and start taxing trusts over which they may not have jurisdiction. While the 2010 proposal was never approved, the New York Department of Taxation and Finance did adopt a new policy of requiring fiduciary returns from resident trusts not subject to tax (see TSB-M-10(5)(I) (July 23, 2012)).
Under current law, non-grantor resident trusts are exempt from income taxation due to lack of jurisdiction if (1) all of the trustees are domiciled outside of New York State, (2) the trust has no New York State source income, and (3) the trust has no real property or tangible personal property located in New York State. The 2010 proposal sought to tax non-grantor resident trusts regardless where the trustees, income, or property is located. The NYSBA Tax Section had already rejected this proposal based on constitutional issues, but was asked to reconsider the proposal by the New York State Tax Reform and Fairness Commission.
In its resulting report, the NYSBA Tax Section referred to two recent cases which reflect the same constitutional issues which caused the section to disapprove the 2010 proposal. Residuary Trust v. Div. of Taxn.,27 N.J. Tax 68 (2013) ruled that the undistributed income of a testamentary trust is not taxable in New Jersey if neither the trustee nor the trust assets are located within New Jersey. In McNeil v. Commr.,67 A.3d 185 (2013), the court found that an out-of-state imposition of the Pennsylvania income tax on trust income does not satisfy the commerce, due process , or equal protection clauses of the constitution. To be internally consistent, the tax must be structured so that, if every taxing jurisdiction were to apply the identical tax, the taxpayer would not be subject to double taxation.
The NYSBA Tax Section report recommended a set of throwback rules as an alternative solution. The throwback rules would tax the trust’s accumulated income at the time of distribution to a New York State resident. The tax would then be imposed on the resident beneficiary rather than the trust, which would mean New York State is taxing a person under their jurisdiction, as opposed to a trust which otherwise had no nexus with the state. This method, the NYSBA Tax Section claims, would avoid any due process or commerce clause concerns.
Still, the NYSBA Tax Section cautioned that the throwback rules must be carefully crafted to avoid constitutional issues, and must take into consideration tax credits, interest charges, exit taxes, and beneficiaries who become New York residents.
The report also examined the unique issue of Delaware Incomplete Non-Grantor Trusts, which the New York State Tax Reform and Fairness Commission had requested. They discussed three problem-solving approaches in the report , which is available at the Bloomberg BNA Tax and Accounting Center.
Continue the Discussion on BBNA’s State Tax Group on LinkedIn : Is the NYSBA Tax Section correct in not approving the 2010 proposal?
By Melissa Fernley
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