Multi-State Trust Taxation
If your trust has connections to more than one state, it may owe income tax in each of them. We sort out which states can tax the trust and handle all the filings.
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Why your trust may owe taxes in more than one state
If you’re the trustee of a family trust, you might expect it to file a tax return only in the state where you live, or where the trust was created. In practice, many trusts have connections to more than one state, and each of those states may claim the right to tax some or all of the trust’s income.
This happens because states use different factors to decide when a trust is subject to their income tax. Some states look at where the person who created the trust (the grantor) lived. Others look at where the trustee lives. A few look at where the beneficiaries live. And if the trust owns property in a particular state, that state can tax the income from it regardless of anything else.
The result is that a single trust can owe state income tax in two, three, or more states in the same year. Without careful attention, the trust may end up paying tax on the same income more than once.
The factors states use
States generally look at one or more of these connections to decide if they can tax a trust:
- Where the grantor lived: Some states, including New York, New Jersey, and Illinois, tax trusts created by a resident of that state, even if the trust has since moved its operations elsewhere.
- Where the trustee lives: States like California and Connecticut tax trusts based on the trustee’s residency. If you’re a California resident serving as trustee, the trust may owe California income tax on its worldwide income.
- Where the beneficiaries live: Some states assert the right to tax trust income based on where the beneficiaries reside, though the Supreme Court placed limits on this in 2019 (see below).
- Where the trust is administered: Pennsylvania and several others look at where the trust’s records are maintained and decisions are made.
- Where the trust owns property: If the trust owns real estate or a business in a state, that state can tax the income from those assets.
The Kaestner decision
In 2019, the U.S. Supreme Court ruled in a case called Kaestner that a state cannot tax a trust’s income just because a beneficiary lives there, if that beneficiary received no distributions, had no right to demand them, and had no control over the trust. This was an important limit on state taxing power.
Kaestner does not mean your state can never tax a trust based on beneficiary residency. If distributions are actually made to you as a beneficiary, your state can likely tax that income. But the decision does mean states need more than just your address to justify taxing trust income you haven’t received.
Can you reduce the number of states involved?
Sometimes, yes. Because state nexus often depends on who the trustee is and where the trust is administered, changing the trustee or the trust’s designated state (its “situs”) can change which states have a claim. This might involve:
- Appointing a trustee in a state with no income tax or lower rates
- Modifying the trust’s governing law or situs provision
- Timing distributions to manage which states have nexus in a given year
These are planning decisions that intersect with the trust document, state law, and tax law. We can advise on the tax implications and coordinate with your attorney on any trust modifications.
How credits work
When a trust is taxed by more than one state on the same income, most states allow a credit for taxes paid to the other state. The credit prevents full double taxation, though it doesn’t always eliminate the overlap entirely. The rules for calculating the credit differ from state to state, and getting them right matters: an incorrect credit claim can trigger a notice or an underpayment.
What we handle
- Identifying which states can tax your trust and why
- Filing resident and nonresident state returns for the trust
- State K-1s for beneficiaries in different states
- Credit calculations to reduce double taxation
- Coordination with the federal Form 1041
- Reviewing the trust’s state exposure for planning opportunities
Frequently Asked Questions
Why does our trust owe taxes in more than one state?
States use different factors to decide when a trust is subject to their income tax: where the grantor lived when the trust was created, where the trustee lives, where beneficiaries reside, where the trust is administered, and where trust property is located. A trust with connections to more than one state may need to file returns and pay tax in each of them.
Can changing the trustee change which states tax the trust?
It can. Several states, including California and Connecticut, base their taxing authority on where the trustee resides. Appointing a trustee in a different state, or replacing a trustee who has moved, can change the trust’s state tax profile. However, some states also look at the grantor’s residency at the time the trust was created, which cannot be changed after the fact.
What did the Supreme Court rule in the Kaestner case?
In 2019, the Court ruled unanimously that a state cannot tax a trust’s income based solely on the fact that a beneficiary lives there, if that beneficiary received no distributions, had no right to demand them, and had no control over the trust. The decision limits how far states can reach, but does not prevent them from taxing income that is actually distributed to a resident beneficiary.
Do beneficiaries also owe state tax when they receive distributions?
Yes. When a trust distributes income to a beneficiary, that income is reported on the beneficiary’s personal return via Schedule K-1. The beneficiary owes state income tax in their state of residence on the distribution. The trust may also owe state tax on the same income in a different state, which is where credits come in to reduce the overlap.