Taxation

Ca. Tax Lawyer 2016, VOLUME 25, NUMBER 1

Order Out of Chaos – Making [Half of] California’s Trust Taxation System Work

By Paul N. Frimmer1

California has a unique system for taxing the accumulated income of trusts.2 In general, California taxes the accumulated income of a trust if any fiduciary resides in California3 or if any beneficiary whose interest is noncontingent resides in California.4 A complete discussion of the entire California statutory scheme for the taxation of trusts is beyond the scope of this article.5 The purpose of this article is to interpret the terms contingent and noncontingent, and to articulate working rules for the taxation of trusts based upon the residence of the beneficiaries.6

If there is a combination of resident fiduciaries and resident, noncontingent beneficiaries, the residence of the fiduciaries first determines how much of a trust’s accumulated income is taxed, and then the residences of the noncontingent beneficiaries are used to determine how much ofthe remaining accumulated income is taxed. For example, assume a trust has two fiduciaries, one of whom is a resident of California and one of whom is not. Assume further that the trust has two beneficiaries, both of whose interests are noncontingent, but only one of whom lives in California. Fifty percent of the trust’s accumulated income is taxable in California because one of the two fiduciaries resides in California. Fifty percent of the remaining accumulated income is taxable in California because one of the two noncontingent beneficiaries resides in California. Accordingly, on these facts, 75% of the accumulated income of the trust is taxable in California.7

Prior to the amendment of section 17742(a) of the California Revenue & Taxation Code ("CRTC"), California taxed the accumulated income of a trust if any beneficiary resided in California, irrespective of whether the beneficiary’s interest in the trust was contingent or noncontingent. Section 17742(a) was amended in 1963 to provide that taxation based on the California residence of a beneficiary was limited to a beneficiary whose interest is noncontingent.8

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