Taxing trusts: navigating the waters of California's income taxation of trusts.

• Author: Abkin, Wendy
• Position: Taxationtips

unlike the law regarding the income taxation of trusts in many other jurisdictions, the grantor residence is inconsequential under California's law. Rather, the income of a trust is taxed by California if the fiduciary or beneficiary (other than a beneficiary whose interest in such trust is contingent) is a resident (Revenue and Taxation Code Sec. 17742).

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A trust's terms determine the extent of a beneficiary's interest in the trust income or corpus, and whether the beneficiary is contingent or noncontingent. For example, when a trust's terms state that distributions to a particular beneficiary are subject to the trustee's discretion, then that beneficiary's interest is contingent because it's subject to the trustee's decision to make a distribution. To the extent the condition is satisfied, however, the beneficiary will be considered to be noncontingent and the applicable tax consequences will follow.

The issue can become more complicated when the trust's terms limit the trustee's discretion or when an otherwise contingent beneficiary is granted powers over trust corpus or income. Additionally, contingencies can lapse over time, as a beneficiary's rights to income or corpus "ripen" if the beneficiary attains a given age, educational status or satisfies other conditions of the trust. Thus, a particular trust's California tax responsibilities can be a moving target, forcing the fiduciary to constantly monitor circumstances.

Fiduciary and Trustee Defined

California law is unique in its use of the term "fiduciary" rather than "trustee." A fiduciary includes a guardian, trustee, executor, administrator, receiver, conservator or any person, whether individual or corporate, acting in any fiduciary capacity for any person, estate or trust (RTC Sec. 17006). However, it's unclear whether a person with a particular title (e.g., a trust protector or trust adviser), responsibilities (e.g.. a member of an investment committee) or lack of responsibilities (e.g., a passive trustee) qualifies as a fiduciary.

If a trust is managed by an institutional or corporate fiduciary, the residence is the place where the corporation transacts the major portion of its administration of the trust [Sec. 17742(b)]--not necessarily the corporation's domicile, headquarters or principal place of business.

The portion of a trust's undistributed income that is taxed by California depends on the percentage of California resident fiduciaries. When a trust...