MCLE SELF-STUDY ARTICLE THE ENDING FOR CALIFORNIA RESIDENTS? CALIFORNIA TAXATION OF INCOMPLETE GIFT NONGRANTOR TRUSTS

Written by Kirsten Wolff, Esq. and Paige S. Voorhees, Esq.^*

I. SYNOPSIS

California has notoriously high personal income tax rates, and its income taxation of trusts is consistent with its anti-taxpayer reputation. California taxes ordinary income and capital gains at the same rates, unlike the federal government, and taxes all or part of a trust’s income if the trust has California source income and/or if a fiduciary or a non-contingent beneficiary is a resident of the state of California.⁰¹

For many years, California residents could establish an incomplete gift nongrantor trusts ("ING") in other states in order to avoid incurring California tax on income from passive assets. Because INGs are intended to be structured as nongrantor trusts for federal income tax purposes, undistributed income generated is taxable to the trust as a separate taxpayer.⁰² Thus, if the trust is set up in a jurisdiction without state-level income tax, such as Delaware,⁰³ Nevada, or Wyoming, there is no state tax payable on any income generated by the trust (unless the income is California-sourced or there is a California fiduciary or non-contingent beneficiary). If an ING includes a limited lifetime power of appointment, which is permitted by Alaska, Delaware, Nevada, South Dakota, and Wyoming,⁰⁴ then the grantor of the ING is able to receive distributions from the trust in later years. This inclusion should make the gift incomplete for federal gift tax purposes. Further, since the transfer of assets to the ING is an incomplete gift, the grantor of an ING should not need to file a federal gift tax return to use any of his or her lifetime gift tax exemption in order to establish the ING.