Income Taxation of Estates and Trusts

• Pages: 377
• Publication year: 2021

Connecticut Bar Journal Volume 65.

65 CBJ 377. INCOME TAXATION OF ESTATES AND TRUSTS

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377

INCOME TAXATION OF ESTATES AND TRUSTS

By FRANK S. BERALL AND SUZANNE BROWN WALSH*(fn*)

The new Connecticut income tax applies (at a 1.5% rate for taxable years beginning in 1991 and 4.5% thereafter) to trusts and estates(fn1) A fiduciary of an estate of a decedent who died after 1990 thus has an opportunity to have the 1.5% 1991 rate apply to two fiscal periods. The election of a short first fiscal year, ending November 30, 1991, will make the estate's second 1991 fiscal year run from December 1, 1991 through November 30, 1992. Thus, income received and retained by the estate from its inception (which could be as early as January 1, 1991, if that was the decedenes date of death) until November 30,1992, would be taxed at only 1.5%. Eleven months of income received during 1992 would thus be shielded from the higher 4.5% rate applicable to fiscal years beginning after 1991.

Of course, federal tax and other considerations may outweigh the advantage of a lower Connecticut tax. Furthermore, the estate will have to stay open as a separate taxable entity until November 30, 1992; otherwise the eleven months of 1992 income received by it and distributed through to the beneficiaries, which is required if its second fiscal year is its year of termination, will be taxed to them at their 4.5% 1992 rates.

The tax is on taxable income, therefore there is no tax in a year in which all distributable net income (hereafter "DNI") is distributed and no capital gains are recognized.(fn2) Nevertheless, an information return will almost surely be required.(fn3) Presumably this would be a regular tax return (Form CT-1041) with Schedule K-1s showing all DNI passing through to the beneficiaries.

I. TAXATION OF RESIDENT TRUSTS AND ESTATES

A. Definitions

A resident estate is one whose decedent was a Connecticut resident. A resident trust is: 1) a testamentary trust under a Connecticut decedent's will; 2) an irrevocable inter vivos trust created by a Connecticut resident; and 3) a revocable inter vivos trust created by a Connecticut resident, which subsequently becomes irrevocable either by the amendment or incapacity or death of the settlor, while the latter is a Connecticut resident.(fn4)

A trust can be a part-year resident. This could happen when a settlor moves to Connecticut, becomes a resident and then, because of incapacity, loses his right to revoke the trust.(fn5) A trust would also become a part year resident upon replacement of its resident trustee by a nonresident.

A resident trust will not be taxed if all its trustees are nonresidents, its entire corpus is located outside Connecticut and all its income and gains are derived from or connected with sources outside Connecticut.(fn6) The fact that such a trust still has resident beneficiaries should not make it a resident trust. A tax cannot be imposed by Connecticut merely because trust beneficiaries reside here, if the trust's assets are possessed by a trustee in another state; otherwise it would violate the due process provision of the Fourteenth Amendment to the federal constitution(fn7)

But, since nonresidents are defined as natural persons,(fn8) the statute appears to require the continued application of the tax where a resident trustee is replaced with an out of state corporate fiduciary. This seems an unintended hardship and is probably unconstitutional.(fn9) Furthermore, there is no good policy reason to restrict the choice of a successor nonresident trustee to a natural person. Therefore, a technical correction to make the exception applicable to corporate trustees is in order.

If a trust which otherwise meets the statutory definition of a resident trust has a provision for its administration under another state's law, this will probably not by itself be sufficient to avoid Connecticut taxation.(fn10)

B. Imposition of Tax

The tax is imposed on the trust's or estate's Connecticut taxable income, defined as federal taxable income plus or minus the fiduciary's share of the Connecticut fiduciary adjustment.(fn11) A trust's Connecticut taxable income also includes the amount of any I.R.C. Section 664 gain, reduced by any deductions properly allocable thereto.(fn12)

C...