The answer will depend on a number of factors. We will cover some of the basics in this post.
No uniform law exists between the states and they range from no-tax states like Delaware to California which has a whole set of tax rules. This makes it important to understand both state and federal tax law. Tax planning advice from an experienced professional can avoid costly and unexpected tax consequences.
Types of trusts
For tax purposes, there are two types of types of trusts classified as grantor and nongrantor. The gains, losses and deductions of a grantor trust flow through to the person who established the trust. Taxes on income accumulated in a nongrantor trust are at the trust level. State tax rates vary and are double digits in California.
Multi-state trust income and distributions
When a trust has property in another state, it is possible to owe taxes in that state. If a Delaware trust owned a rental property in California, the income would likely be subject to California taxes.
Generally, a state cannot tax undistributed income in the trust unless there is a connection to the state. What qualifies as a “nexus” or adequate connection could be as minor as a trustee or beneficiary living in the state. It is even possible to owe taxes in two states. A Missouri trust may pay state taxes, but a California beneficiary may also owe California taxes on a distribution.
A tax attorney can answer specific questions and ensure a trust is set up properly. If you have received a letter from the California Franchise Tax Board or the Internal Revenue Service related to the taxation of a trust, an attorney can also help you resolve the matter.
Source: Barron’s.com, “Can Another State Tax Your Trust?” Amy Feldman, May 16, 2015.