Trusts are very useful tools when it comes to estate planning. Their uses in this area include protecting and providing for children, tax planning benefits, professional management of assets, among others. But trusts do have their own unique challenges.
One of the challenges in trust and estate administration is managing federal and state tax law compliance. Focus is often placed upon federal law compliance, but state income taxation issues should not be forgotten.
Some states do not tax income related to trusts, but those that do have a variety of rules and criteria for which trusts are subject to tax. Attorneys and CPAs working with those engaged in estate planning should be aware of the rules.
Some states have no income tax at all; some base their tax on where the person creating the trust lived at the time the trust was created or the time it became irrevocable; still others base it on where the trust is being administered, where a trustee lives, or where a beneficiary lives.
One difficulty that can arise in this area is when a trustee changes residency to a different state. This could, in some situations, trigger state income tax on the trust in the new state. When this isn’t caught for years, unpaid taxes, interest and penalties will follow. Laws change over time, and it can be difficult to keep track of what it going on currently.
The best defense against surprise situations is for trustees to arrange for periodic reviews of the trust in connection with state income tax laws, and to develop a system for tracking state requirements and other factors that could potentially trigger state income taxes.
Source: Wall Street Journal, “Trust, But Verify Your Estate Tax Planning,” Roger Russell, March 21, 2012