A Trust May Be Subject to California Income Taxation if the Trustee Resides in California

By S. Eva Wolf

California aggressively taxes non-grantor trusts. A non-grantor trust with a California resident trustee may be subject to California income taxation even if none of the assets of the trust are located in California, none of the beneficiaries reside in California and the trustor never lived in California. This often comes as a shock to trustors, trustees, and their respective accountants and estate planning attorneys.

California income taxes on the income of such a trust could be significant. California income tax rates are as high as 13.3%, and there is no preferential capital gains tax rate. Since the requirement to pay California income taxes may not be discovered for many years, the trust also could owe interest and penalties.

This result can be avoided or mitigated with proper estate planning. For example, the trustor can designate non-California residents as the initial and successor trustees of the trust or, for trusts that are already in existence, the California resident trustee could resign, provided the successor trustee is a non-California resident.

Even if California income taxation is avoided or mitigated, a non-grantor trust may still be subject to income taxation by another state. Connecticut, Pennsylvania, Illinois, and New York impose income taxes on trusts created by their residents, while Delaware imposes income taxes on trusts whose beneficiaries are residents. States that do not impose income taxes on trusts include Alabama, Florida, New Hampshire, Nevada, South Dakota, Texas, Washington, and Wyoming.

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