Weekly Round-Up: Are States Pushing the Limits of Trust Taxation?

As states more aggressively seek to impose taxes on trusts, some practitioners may question whether the states are exceeding their constitutional authority, Thomas W. “TJ” Aldous Jr., a partner with Williams Mullen's Private Client & Fiduciary Services Team, writes in this week’s issue of the Bloomberg BNA Weekly State Tax Report

U.S. Supreme Court cases considering whether a state could constitutionally tax a trust have been based on an understanding of basic trust principles, Aldous writes. However, some courts and state tax departments have seemingly misunderstood the nature of a trust and this, in turn, has caused uncertainty. Further, states have a financial incentive to define resident trusts broadly, because the state generates more revenue by taxing the worldwide income of a resident versus the tax on source income of a nonresident, Aldous explains. 

Due process requires that a state have minimum contacts with the person it seeks to tax, Aldous explains.  In jurisdictional matters, the trustee has always been the required link to the state. 

Statutes in more than half of the states, including Virginia, could be interpreted to impose a tax on a trust that has no resident trustee. These states assert that a trust is an entity or that a nonresident trustee has a relationship, or minimum contacts, with the state through the presence in the state of the settlor, the beneficiaries or trust assets, Aldous states. Asserting nexus with a nonresident trustee by way of a resident settlor, beneficiary or trust assets is not consistent with U.S. Supreme Court precedent or with general trust law, according to Aldous. 

When a trustee is not present in the state, states, like Virginia, rely on the state's contacts with the settlor, the beneficiaries or trust assets to assert jurisdiction and they ignore the elements of just control over the trustee and purposeful availment by the trustee, Aldous says. 

A state may argue that the presence of trust assets in the state grants jurisdiction. Some states assert nexus and tax a trust based on the presence of a beneficiary in the state, Aldous said. 

Check out the article by Aldous, which offers a discussion of constitutional issues that come up when states try to impose income tax on trusts, including concerns regarding the Due Process Clause and Commerce Clause, here. The article also addresses divergent court opinions from various states and offers insight on how to reconcile them. 

To find out more about each state's position on trust nexus, sign up for a free 7-day trial of Bloomberg BNA’s State Tax Nexus Tools.  

   In other developments…  

        When is My State’s Tax Freedom Day? by the Tax Foundation 

      New York Tax Insights, April 2014, by Morrison & Foerster LLP 

      Virginia – Ten year retroactive limitations placed on addback exceptions, by PwC 

   Compiled by Priya D. Nair 

   Follow us on Twitter at:    @BBNATax
Join BNA's State Tax Group on LinkedIn   here.