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Trust Nexus Survey - Pennsylvania's Trust Taxation is Among Most Lenient

Tax

By Marko Zivanov

A recent survey by Bloomberg BNA[1] analyzes key factors driving state taxation of trusts.  It offers interesting insights into the criteria that states use for determining if a trust is subject to income tax. The survey identifies seven actions creating sufficient nexus to trigger application of a state's income tax:

  1. Using the state's law as the governing law of the trust;
  2. Administering the trust in the state;
  3. Having a settlor that is a resident of the state;
  4. Having a trustee that is a resident of the state;
  5. Having a beneficiary that is a resident of the state;
  6. Owning assets located in the state;
  7. Receiving state-source income.

The majority of states impose a tax on trusts based on three or four of the above-listed factors.  Pennsylvania is one of a few states least likely to tax trusts identifying nexus-creating activities in only two categories: having a settlor that is a resident of the state and receiving state-source income. At the same time, there are states that will impose tax based on any of the seven categories. Additionally, states afford different weight to the factors.  Factors most likely to trigger taxation are:  owning assets located in the state (34 states), having a settlor who is a resident of the state (32 states), administering the trust in the state (25 states).  The activities that are least likely to trigger taxation in most states are: having a resident beneficiary (11 states) and using a state’s law as the governing law of the trust (12 states).

Excluding no-tax states (AK, FL, NE, SD, TX, WA, WY), states imposing the tax vary significantly regarding the rates. Pennsylvania has the lowest rate at 3.07% and California is the highest at 12.30%.

Some characteristics of a trust can be more controllable than others.  For example, the state where the trust is administered, the trust’s governing law or the location of the trustee can be easily changed.  Other attributes of the trusts are less controllable: location of trust’s fixed assets or residence of a beneficiary. Some are even impossible to change such as the settlor’s residency at the time of creation of the trust. Trustees and those administering the trusts need to monitor a variety of factors that could impact trust taxation in state jurisdiction.  For instance, beneficiaries or trustees sometimes move easily between places of residence and some states are taxing trusts based on the presence of beneficiary or trustee within its borders.

Given the tax rate and a low number of factors that it considers when it imposes a tax, it is clear that Pennsylvania is very kind when it comes to the trust taxation.  Furthermore, a recent Pennsylvania case[2] limited the trust taxation even more. The court declared that it is unconstitutional to impose a tax on a trust whose only connection to the state was that it was formed by a Pennsylvania resident and that discretionary beneficiaries are Pennsylvania residents.

The complexity of state trust taxation is often overlooked, and many of the state standards can change year by year. Therefore, settlors, trustees and beneficiaries might wish to regularly review the above-listed factors in order to minimize the trust’s state income tax implications.

[1] BNA Special Report, 2013 Trust Nexus Survey

[2] McNeil v. Commonwealth of Pennsylvania, 67 A.3d 185 (Pa. Commw. Ct. 2013)

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

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