Trust Situs

Some states are contemplating new taxes that could cause trusts in those states to be taxed. Depending on where they’re based, there could potentially be a greater burden on the trustees and the beneficiaries regarding the reporting and taxation of trust income. Understanding what’s happening in the state where your trust situs is based is important.

Additionally, there may be an option to make distributions from a trust and better utilize the Section 199A deduction, which provides a 20% deduction on qualified business income. This can be complicated, but trustees might want to ask whether the beneficiaries need additional income to fully utilize the deduction or if too much would result in a phaseout of the deduction. The trustee must pay attention to whether or not there would be uneven distributions which are proper and the eventual effect on future distributions. 

There are other taxes that could be affected by distributions. The net investment income tax of 3.8% is on a portion of the adjusted gross income over certain thresholds—generally $200,000 if single and $250,000 if married filing jointly. If distributions occur when there are multiple beneficiaries, there may be tax at the trust level but not at the beneficiary level.

With the $10,000 limit on state and local tax deductions, trustees may need to monitor distributions, particularly when distributable net income will face a greater tax burden due to the lack of the deduction. Consider if the tax benefits outweigh other issues, such as asset protection and unequal distributions.

Planning Opportunities

  • Explore if trust situs should be changed to a more trust-favorable state if the current resident state is contemplating an increase in income or commerce tax.
  • Review state taxation of non-grantor trusts that accumulate income, which affects corpus and income for future beneficiaries. Determine if a distribution should occur and for what reason.
  • Consult state rules against perpetuity to see if it’s possible to exempt estate, gift, and generation-skipping transfer tax for a substantial period of time.
  • Look to the statutory rights to change trust through the decanting provision according to what the state provisions allow. Determine if there more flexible provisions that can be added to an existing trust.
  • Consider the effects of gifts because of the potential claw-back provisions.
  • Consider if a charitable trust still allows access to income as well as if a charitable remainder trust can be formed to provide annuity income to additional beneficiaries while still reducing tax liabilities.
  • Consider whether decanting your current trust can impact the income tax liability of the trust. Further review whether or not trust accounting income and distributions are being reviewed for tax efficiency.
  • Consider restructuring your family office to better utilize certain expenses and maximize all available deductions.

More Resources

The IRS issued proposed regulations clarifying a potentially significant tax break—aggregating your trades or businesses for a pass-through, or Section 199A, deduction.

On August 8, 2018, the Treasury and the IRS issued new proposed regulations for the Qualified Business Income deduction under Section 199A.

A new qualified business income deduction provides tax relief to owners of certain domestic trades or businesses operating as pass-through entities.

Taxpayers who own and operate businesses through pass-through entities could benefit from a new qualified business income deduction.

Individuals will need to consider the effects of President Trump’s tax reform in their 2017 income taxes.