\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0To What Extent Can Massachusetts Residents Continue to Serve the Trust Without Jeopardizing the Trust's Non-Resident Status?
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0A. Bay State Trusts that Stand to Benefit from Migrating North.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The Commonwealth's definition of "resident trusts" that are subject to Massachusetts state income taxation on all of their income and gains is narrowly drawn to exempt income and gains from sources outside Massachusetts of non-grantor, inter vivos trusts with no Massachusetts resident trustees. This creates an opportunity for current resident non-grantor trusts to avoid any continuing state income tax obligations on their accumulated non-Massachusetts source income and capital gains. It can be accomplished by replacing current Bay State resident trustees with successor trustees residing in New Hampshire or other states that will not tax the trusts.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0If the new trustee is a New Hampshire resident, the trust can avoid state income taxation entirely since New Hampshire has no broad-based income or capital gains taxes. Furthermore, as of January 1, 2013, trusts are exempt from the New Hampshire interest and dividends ("I & D") tax.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The ideal candidate for such a move: a substantially funded, long-term, non-grantor inter vivos trust, all or most of the beneficiaries of which are Massachusetts residents, that makes no or modest annual distributions to Massachusetts resident beneficiaries with few or no New Hampshire resident beneficiaries. The potential for significant state income tax savings exists primarily for non-grantor trusts treated under Subchapter J of the Internal Revenue Code as "complex trusts" that historically accumulate all or a substantial portion of their distributable net income ("DNI"). Massachusetts law incorporates the grantor trust rules of Code §671 et seq.4 Therefore, changing the situs of a Massachusetts grantor trust will not secure any tax savings because the income and capital gains will continue to be taxed to the trust's settlor. For "simple trusts" that require mandatory income distributions to Massachusetts beneficiaries, and complex trusts that historically make substantial annual distributions and are likely to continue to distribute all or a substantial portion of their DNI to Massachusetts resident beneficiaries, a situs change can save taxes on capital gains but not ordinary income, as the Massachusetts resident beneficiaries' Federal K-l income will continue be taxed in the Commonwealth. For those trusts, a relocation might be appropriate only if the trustee expects to realize substantial capital gains from anticipated sales of highly appreciated holdings, assuming that the sale does not occur in the trust's final taxable year, or the trust document does not include capital gains as part of DNI as might be the case with a total return style equitable adjustment regime or unitrust conversion.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0So decamping to New Hampshire won't save state income taxes for all current Massachusetts resident trusts. Still, there remains a potentially large universe of Massachusetts trusts that might be good candidates. The current Massachusetts trustees and the beneficiaries of the trusts they serve will often be interested in availing themselves of these opportunities without completely severing the relationship with the resigning Massachusetts resident trustees and other local advisors that the family may want to continue to actively participate in important settlor and beneficiary-facing discretionary powers relating to trust investments and distributions. Many families will want the New Hampshire resident trustees to perform as minimal a role as possible in the trust's administration to achieve the tax savings.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Can the family's Massachusetts resident trusted advisors, be they current trustees, attorneys, accountants, investment advisors or family members, continue to perform important trust functions as non-trustees without risking the trust's continued taxation by the Massachusetts Department of Revenue ("DOR") ? This article will attempt to provide some guidance for those families and Massachusetts resident advisors who are interested in having it both ways.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0B. Applicable Massachusetts Trust Taxation Principles: Relevant Statutory, Common Law and Regulatory Authorities.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA01. Statutory. The pertinent provisions concerning trust income taxation are found in M.G.L. Ch. 62, particularly §10(a)-(e). The determination of the taxation of a trust with Massachusetts connections is a two-step inquiry.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0First, is the trust a resident or non-resident trust? Resident trusts include: (i) testamentary trusts created under the will of Massachusetts decedents, and (ii) inter vivos trusts with at least one Massachusetts trustee if at least one grantor was a Massachusetts resident at the creation of the trust, at death, or during any part of the tax year at issue. M.G.L. Ch. 62, § 10 (a), (c). Anon-resident trust is taxed only on Massachusetts source income. M.G.L. Ch. 62, §§5A, 10(d).
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Second, for a resident trust, are the beneficiaries Massachusetts residents? The share of the income of a Massachusetts beneficiary is taxed to the trust under M.G.L. Ch. 62, §10(a). Anon-resident beneficiary's share of the income is taxed to the beneficiary. Unborn persons, ascertained members of a class, and persons with uncertain interests are treated as if they were residents of Massachusetts, and income accumulated for these persons is taxed to the trust. M.G.L. Ch. 62, §10(a). The rates applicable to the various categories of Massachusetts taxable income vary from 5.2 percent to 12 percent in 2014, and are discussed in more detail in note 2 above and the accompanying text.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA02. Common Law. Harrison v. Commissioner of Corps. and Taxation, 272 Mass. 422, 172 N.E. 605 (1930), stands for the proposition that the state of residence of the creator of a testamentary trust may establish a permanent situs for taxation in that state, and if it does so no other state may also tax the trust income. At issue was the ability of Massachusetts to tax capital gains of a testamentary trust of a New York decedent with Massachusetts resident trustees, where the gains were also subject to New York tax. The SJC held that under principles of interstate comity, the trust had insufficient current contacts with the Commonwealth to justify the assertion of the DOR's taxing jurisdiction:
We think that it is within the competency of New York to require that the intangible personal property of one its deceased residents, whose will has been allowed by its court acting as the court of the domicil [sic] of the decedent, in the custody of fiduciaries appointed by such court to hold and administer that intangible personal property according to the will of the deceased resident and being so held and administered by such fiduciaries with responsibilities for accounting to that court, shall have and continue to have a situs for taxation within its jurisdiction.. .That conclusion.. .rests on the power of the State to establish a situs for purposes of taxation over a testamentary trust fund created by its deceased residents in intangible personal property being administered by appointees of its own court, under its laws, and thus for practical purposes within its jurisdiction all control over the trust and especially control for purposes of taxation.
The conclusion rests also upon interstate comity which except in unescapable circumstances would not permit taxation in this Commonwealth of property thus within the jurisdiction of another state.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The case also involved a Massachusetts income tax imposed on a District of Columbia testamentary trust on the basis of the residence of one (of three) trustees. Unlike the New York testamentary trusts the SJC considered, over which the Court held New York had established exclusive taxing jurisdiction, no such showing was made for the District of Columbia trust. Nonetheless, the judges held that all the income could not be taxed in Massachusetts on the basis of the residence of one of three trustees. "Otherwise.. .if the state of residence of each trustee exerted to the full its taxing power, the entire income of the trust would be subject to three different taxes in each of three States." The Court also declined to accept the DOR's invitation to construe the statute as taxing only a pro rata portion (one-third) of the income, since "... the words [of the statute] are not susceptible of that construction."
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Although Harrison is somewhat dated, it does have some precedential value for the SJC's unwillingness to give the DOR and the legislature a blank check to overreach in...