Recently, in a closely watched case, the California Superior Court in San Francisco rejected the FTB`s approach to trust taxation, noting that all income, including California income, is subject to the allocation formula set out in sections 17743 et seq. of the California Revenue & Taxation Code (Paula Trust v. California Franchise Tax Vol., No. CGC-16-556126 (Cal. Super. No. 3/7/18)). If this decision is upheld, California income tax could be deferred for several years (i.e., until the income is distributed to beneficiaries). In 2018, the trustees won at the level of the court of first instance.
The Court of First Instance agreed with the trustees` interpretation of the Statute (Cal. Rev. & Taxation. Cd. § 17743), which allows the trust to divide all income according to the trustee`s place of residence, whether or not the income comes from California. The trial court also agreed that the sole beneficiary of the trust was a potential beneficiary because the trustees were not required to make distributions to them. FTB appealed the decision of the Court of First Instance. On appeal, the California Court of Appeals, the first district of appeals, disagreed with the trial court`s interpretation of the law. The court found that simple legal language allows trusts to divide only their non-California source income based on where the trustees live. In addition, the law specifically includes the FTB Regulation, which allows trusts to divide only their non-California source income based on where the trustees live. The Court of Appeal also found that the legislative history supports ftB`s interpretation of the act. As a result, the Court of Appeals ruled that all of the trust`s withholding income in California is subject to tax.
However, the Court of Appeal upheld the trial court`s view on the second issue: that the sole beneficiary of the Paula Trust was a prospective beneficiary. Therefore, the trust would not be taxable on all of its income based on the beneficiary`s California residency, and the trust`s non-California source income is redistributable. States will also tax non-resident trusts based on some of the five criteria listed above. For years, the California Franchise Tax Board (FTB) has held that trusts are subject to California income tax on all of their California income and that non-California income is prorated by the number of California trustees and non-constitutive beneficiaries (see Cal. Regs Code. titmouse. 18, § 17743). Filip Babic is an attorney with the san jose law firm of Steven L.
Walker PLC. He advises corporations, individuals, trusts, estates, investors and associates in connection with tax controversies and litigation before the IRS, the California Franchise Tax Board, and national and local tax authorities. To comment on this article or suggest an idea for another article, please contact Sally Schreiber, Editor-in-Chief, at [email protected] This article focuses on retrospective tax in California, which is generally not understood by practitioners or trustees and beneficiaries of trusts.1 The Deductible Tax Board (FTB) regulations do not provide guidance on how to determine the amount of accumulated income attributable to the beneficiary. Although the California trustee`s tax return (Form 541) and instructions deal with relief tax, the form and instructions do not fully determine the application of the Return Tax Act. In this article, we explain our interpretation of the intent and application of this law, propose a methodology for tracking income accumulated in non-California trusts in order to implement law enforcement, and explore ways to plan for tax. Trustees or beneficiaries of trusts who may be concerned about a tax compliance issue in California should contact a qualified tax advisor who will consider whether voluntary disclosure makes sense. While the proceeds from the sale of the stake in Century Theatres were undeniably California income, the taxpayer argued that Rev. & Tax.
Sections 17743 et seq. of the Code. is the exclusive basis for the taxation of fiduciary income. In particular, the taxpayer argued that the FTB`s order was inconsistent with the clear interpretation of the law because “it is stated elsewhere in section 17743 or any other law that the taxable income of the trust includes income from real estate or business activities from California” (Memorandum of Points and Authorities in Support of Plaintiff`s Motion for Summary Judgment or Summary Adjudication, p. 8 (10/5/17)). In response, the FTB argued that Rev. & Tax. Sections 17951 et seq. of the Code provide that non-residents are subject to tax on their California income and that, therefore, California income is not payable (Memorandum of Points and Authorities in Opposition to Plaintiff`s Motion for Summary Judgment or Summary Adjudication, at p. 15 (10/5/17)).
If the California Supreme Court agrees to a review and later overturns the Court of Appeals and assumes the taxpayer`s position, such an assumption would significantly alter the taxation of trusts with California income to the extent that the trusts have non-resident trustees or unconditional beneficiaries. These potential changes may include not only taxing trusts in a particular taxation year, but also tracking and processing previous amounts from the trust`s “California sources” that will be distributed and taxed on beneficiaries at a later date. A trust may be considered a resident by more than one state. Only seven states have no fiat income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. That leaves 43 states plus the District of Columbia that can tax the trusts. Trusts are generally taxed on retained income and capital gains. If income is taxed in more than one state, a credit note may be available. Not surprisingly, the FTB appealed the decision, so it remains to be seen whether trusts with non-resident trustees or beneficiaries can divide their California income. However, trusts whose California income is potentially attributable should contact a competent tax professional and consider filing a protection refund claim to preserve their rights if the decision is upheld on appeal. In general, FTB will postpone the refund request until the dispute is resolved. There is a solution for trusts that do not meet their tax obligations in California.
The California Franchise Tax Board has a voluntary disclosure program that allows qualified businesses, such as trusts, that may have incurred an unpaid tax liability in California or an unfulfilled reporting obligation, to voluntarily disclose their liability. The Franchise Tax Board (FTB) waives penalties associated with tax returns and has a six-year review period. The Voluntary Disclosure Program allows trusts to comply with taxes. To the extent that trusts with non-state trustees and prospective beneficiaries have generated revenue from California, they should consider the advisability of filing claims until there is a possible review of the matter by the California Supreme Court. In 2007, the trust sold a portion of its assets, resulting in taxable income of approximately $2.8 million from California. At that time, the Trust had two trustees; one was a California resident, the other was a Maryland resident. Paula Syufy Medeiros, the only beneficiary, lived in California. As the trustees did not make any distributions to Paula that year, Paula was considered a potential beneficiary in 2007. The trust filed a tax return in 2007 and reported and paid taxes on the total capital gain of $2.8 million from the sale of the business interest. A trust is an agreement to hold and manage property, usually in a written document, in which someone (a trustee) is responsible for managing the property for someone else (beneficiary). In addition, the court held that the California-based beneficiary`s interest in the trust was conditional because the trust instrument gave trustees absolute discretion to make distributions.
Generally, a trust in California is subject to tax “if the trustee or beneficiary (other than a beneficiary whose interest in that trust is conditional) is a resident, regardless of where the trustee resides.” See Cal. Rev. & Tax 1774(a). This means that a trust has a California tax filing obligation if the trustee or beneficiary whose interest is not conditional is a California resident. The taxpayer asked the California Supreme Court to review the decision. The following example illustrates how the two-tier system works: If a trust has a mix of California resident and non-resident trustees or non-equal beneficiaries, the trust`s income is divided using the applicable two-tier splitting formula. (See legal notice FTB 98-12). . . . .