On June 27, 2023, California lawmakers passed Senate Bill 131 (SB 131) to amend California Revenue and Taxation Code section 17082. This new law states that effective Jan. 1, 2023, the income of an incomplete non-grantor (ING) trust will be subject to California income tax if the grantor resides in California, regardless of the jurisdiction in which the trust was formed.
DEFINITION OF INCOMPLETE NON-GRANTOR TRUST
An ING trust is set up to transfer assets into the trust, which would then be treated as a separate taxpayer for income tax purposes. These transferred assets are considered not-completed gifts since the grantor maintains some element of control or benefit. The primary reason individuals would set up these trusts was to eliminate the state income tax they would owe on these transferred assets by having the trust administered in a non-tax state.
Although the income generated in the ING trust was previously not subject to California tax, any distributions made to beneficiaries would be claimed as a deduction for the ING trust and picked up as income on the beneficiaries’ return.
CALIFORNIA INCOME TAX ON INCOMPLETE NON-GRANTOR TRUSTS
Effective Jan. 1, 2023, ING trust grantors will be required to report the trust’s income on their California income tax return. The grantor will now be treated as the owner of these assets and will be subject to California income tax. This law, however, does not impact the federal taxation rules of the ING trust.
The income generated by an ING trust prior to Jan. 1, 2023 will not be subject to the new law, and individuals will not be required to amend their returns. California, however, has a throwback rule so that trust distributions made in later years will trigger a tax on any accumulated undistributed income in California.
- SB 131 will now require all settlors of ING trusts who are California residents to pick up any income generated from the trust on their personal return in California as if it was a grantor trust. This means the federal taxation will be inconsistent with California and require additional review and calculations for state purposes.
- All prior undistributed accumulated income will still be subject to California’s throwback rules and be subject to tax once distributed to the beneficiaries.
- As a result of this new law, California grantors who establish an ING trust in a state without personal income tax, such as Nevada, will be subject to tax in California with regard to the trust income.
- o If an individual is contemplating a transaction, restructuring or selling interest (owned through an ING trust) in a partnership with a settlor domiciled in California, then it is important to understand the tax implications of this new law.
The provisions of SB 131 are complex and nuanced. Please contact GHJ’s State and Local Tax Team for any questions related to planning opportunities or questions about SB 131.