New Jersey case brings national attention to taxation of trusts

Trusts are subject to state and federal laws. State taxation laws were recently questioned in a series of court cases, including one out of New Jersey.

Trusts are legal tools that can help individuals and families take advantage of tax planning. When used correctly, these tools have the potential to help reduce tax obligations and increase one’s overall wealth, including the assets passed on to future generations.

Trusts are complex for a number of reasons, including the fact that they are governed by state and federal laws. This complexity was recently highlighted in a series of cases that will impact how trusts are taxed. Taxation is generally based on the location of the trust, allowing that state’s laws to govern. However, finances are much more mobile than they were in previous generations. This has led to a number of trusts that are created in one state, administered in another and funded with assets in yet another. These complexities have made it difficult to determine which state’s taxes apply.

A case out of New Jersey is receiving national attention for its decision on this issue.

More on the case

The case, Residuary Trust A. v. Director, involved a testamentary trust created at the time of the creator’s death. The creator was a New Jersey resident, but the trust was administered out of New York and funded, in part, outside of the state. The trustee paid tax on the portion of the trust’s income that was allocated in New Jersey. The Director of the Division of Taxation for New Jersey issued a Notice of Deficiency for $192,379, claiming the undistributed trust income was taxable in its entirety under New Jersey law.

The trustee protested the Notice and requested a hearing. During the hearing, it was determined that even though a large portion of the trust’s assets were allocated outside of the state, state tax law still applied. The trustee appealed to the Tax Court of New Jersey. The Court reviewed whether the trust had “sufficient contact” with the state to justify taxation. Ultimately the court found the state could only tax the portion of the trust’s income that was allocated to New Jersey.

Future impact on trust taxation

This and other recent court decisions will impact the way trusts are taxed. In some cases, an analysis of the connections of the trust to various states may be needed to help determine which state’s taxation laws apply. Some potential issues for analysis include the residence of the beneficiaries and fiduciaries, location of trust assets, source of trust income and location of creator.

It is likely that the laws governing taxation of trusts will continue to change. As a result, those who are interested in setting up a trust or who currently have trusts in place are wise to seek the counsel of an experienced trusts attorney. This legal professional can work with you to better ensure the trust meets your needs.

Keywords: estate planning