By Sharon L. Klein

On May 16, 2014, the New York Department of Taxation and Finance issued TSB-M-14(3)I, a Technical Memorandum containing “Important Information for Beneficiaries and Grantors of Exempt Resident Trusts.” In response to inquiries from the New York City Bar Association, where I Chair the Trusts, Estates and Surrogate’s Court Committee, the Department has just provided further clarification.

As I have previously described, on March 31, 2014, the New York State legislature passed the Executive Budget for 2014-2015, bringing with it important changes to the income taxation of trusts:

1. Throwback Tax

Under existing New York Tax Law, an income tax is imposed on the income of a “resident trust,” which includes a trust created by a New York domiciliary. However, prior law provided that a resident trust would be exempt from tax if three conditions were met: (1) there were no New York trustees, (2) there was no trust property located in New York, and (3) there was no New York source income. While it does not impose a tax at the trust level, the new law does tax distributions of accumulated trust income (apparently not including capital gains) to New York beneficiaries of these exempt resident trusts. Although the original proposal would have taxed distributions of income accumulated in earlier years, in response to Bar Association feedback, the final legislation applies only to distributions of income accumulated in taxable years beginning on or after January 1, 2014.

2. Incomplete Gift Non-Grantor (“ING”) Trusts

Changes were also made to the taxation of so-called “INGs” – incomplete gift, non-grantor trusts. These trusts were structured as incomplete gifts for gift tax purposes so that no gift tax was payable, but as separate taxpayers for income tax purposes. The goal was for a New York resident to structure the trust so it was not subject to state income taxation by establishing it in a jurisdiction that did not impose an income tax on the trust. If appreciated property transferred to an exempt resident trust was sold, it might not have been subject to New York income tax that otherwise would have been payable had the New York resident grantor sold the property himself. Under the new law, ING trusts will be treated as grantor trusts for New York purposes. That is, the income and gains of the ING trust will be includible in the income of the New York grantor, although the trust will remain a separate taxpayer for federal purposes.

The new law is applicable to tax years beginning on or after January 1, 2014. However, the law excludes from tax: (1) distributions of accumulated income by exempt resident trusts (except ING trusts) made before June 1, 2014; and (2) income earned by ING trusts that are liquidated on or before June 1, 2014.

TSB-M-14(3)I: New York State Department of Taxation and Finance Issues Guidance Regarding Specific Actions That Take Place Before June 1, 2014.

With the goal of providing further guidance, TSB-M-14(3)I provides that the following provisions of the new law do not apply to specific actions that take place before June 1, 2014:

  • Accumulation distributions made to New York resident beneficiaries by exempt resident trusts will not be required to be included in the beneficiaries’ New York adjusted gross income (NYAGI) if the distributions are made before June 1, 2014. However, incomplete gift non-grantor trusts are not subject to this provision.
  • The income of an incomplete gift non-grantor trust will not be required to be included in the grantor’s or beneficiaries’ NYAGI if the trust is terminated and all assets are distributed before June 1, 2014.

After the issuance of TSB-M-14(3)I, the New York City Bar Association posed the following queries to the Department:

  1. Regarding the first bullet point above: What is the significance of the June 1 date? If the new law applies only to income accumulated after January 1, 2014, how could an accumulation distribution be made before January 1, 2015?
  2. Regarding the second bullet point above: Ordinarily, a terminating distribution from an ING trust would result in a New York grantor having to include all the distributable net income (including capital gains) in his or her NYAGI. Was the intent of TSB-M-14(3)I to override the usual result and allow ING trusts to be terminated and their assets distributed to the grantor before June 1, 2014, without the grantor having to pay tax on the distribution?

Further Clarification by the New York State Department of Taxation and Finance

In response to these queries, the Department just provided the following reply:

“1. Based on our understanding of the legislative intent underlying Part I of Chapter 59 of the Laws of 2014, the Department is interpreting the language of Section 9 of Part I to mean that income related to an ING trust that will become subject to tax under Section 612(b)(41) as of June 1, 2014, should not be subject to tax prior to that date, even if the income is included in Federal AGI, the starting point for calculation of the New York tax. That is, the second bullet of TSB-M-14(3)I does in fact mean that ING trusts may be terminated and their assets distributed to the grantor before June 1, 2014, without the grantor having to pay tax on the income distributed. In order to implement this interpretation, a subtraction modification for such income will be available on the 2014 New York personal income tax return. The modification will not be allowed beyond 2014.

2. The original budget bill disregarded income earned by trusts in any taxable year starting before January first, two thousand eleven. To mitigate transition issues, Section 9 of Part I of Chapter 59 excluded distributions of accumulated income made before June 1, 2014. When Section 1 of the bill was amended to disregard income earned in any taxable year starting before January 1, 2014, it made the exclusion of distributions made before June 1, 2014 contained in Section 9 unnecessary. Section 9, however, was not amended.” (In other words, that date is an inadvertent vestige of a prior bill version).

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