Wednesday, February 3, 2010

Proposed New York Legislation to Eliminate the Income Tax Exemption for Resident Trusts

On January 19, 2010, Bill A09710 was introduced in the New York State Assembly which would amend the definition of a “resident trust for tax years beginning on or after January 1, 2010. This Bill will affect persons who have changed the tax situs of a trust from New York to another jurisdiction through the use of nonresident trustees.

Section 601(c) of the New York Tax Law (“Tax Law”) imposes an income tax on the income of a “resident trust.” Section 605(b)(3) of the Tax Law defines a resident trust to include: (1) a trust created by a New York decedent; (2) an irrevocable trust created by a New York resident; or (3) a trust that become irrevocable while the creator was a New York resident.

Notwithstanding the general rule of Section 601(c), Section 605(b)(3)(D) of the Tax Law was introduced as a result of the 1964 New York Court of Appeals decision in Mercantile-Safe Deposit & Trust Co. v. Murphy. Section 605(b)(3)(D) provides that a resident trust will not be subject to tax if three conditions are met: (1) all trustees are domiciled in a state other than New York; (2) the entire corpus of the trust, including real and tangible property, is located outside New York; and (3) all income and gains of the trust are derived from or connected with sources outside of the f New York.

Bill A09710 would repeal Section 605(b)(3)(D), eliminating all three conditions for tax exemption. The Bill provides that a testamentary trust created under the will of a New York domiciled decedent would be deemed a New York resident trust and the income of such trust would be fully taxable in New York. A nontestamentary trust settled by a New York resident grantor would also be considered a New York resident trust. A resident nontestamentary trust with New York source income would be fully taxable, while a resident nontestamentary trust with no New York source income would be taxed based on the proportion of identifiable beneficiaries of the trust who are New York residents.

The purpose of A09710 is to prevent a trust settled by a New York resident from avoiding New York through the use of nonresident trustees.

A text of Bill A09710 is available here. Part G of the Bill addresses the taxation of resident trusts.