All about business September 2020 Tax News

Clarification on how California taxes trusts

A trust is a taxable entity separate and apart from its beneficiaries.[1] In order for California to tax the income of a trust, one or more of three separate elements must be present:

  1. The trust must have income from California sources[2]
  2. A trustee of the trust must be a resident of California[3]
  3. A non-contingent beneficiary of the trust must be a resident of California

Under both Federal and California law, non-grantor trusts are taxable at the trust level on accumulated income.[4]

For many years, we have taken the position that trusts are subject to California state income tax on all of their California-source income, and that non-California-source income is apportioned pro rata according to the number of California fiduciaries and noncontingent beneficiaries (see Cal. Code Regs. tit. 18, §17743). Recently, in a published decision, THE COURT OF APPEAL OF THE STATE OF CALIFORNIA, FIRST APPELLATE DISTRICT (Steuer v. Franchise Tax Board, No. A154691 (Cal. Ct. App. 1st Dist. June 29, 2020, commonly referred to as the Paula Trust case) affirmed that a Trust’s entire California source income is subject to California taxation, regardless of the residency of the trust’s fiduciaries.

The court held, “The plain language of Section 17743 and its rules require taxing all of a trust’s California-source income and then apportioning only income derived outside of California according to the number of resident fiduciaries. (Section 17743; Cal. Code Regs., tit. 18, Section 17743.)”

Visit our Estates and trusts webpage for more information.

[1] Internal Revenue Code Section 641; California Revenue and Taxation Code (R&TC) Section 17731 (conformity with Federal law).

[2] R&TC Section 17951 (California source income). 

[3] R&TC Sections 17742 and 17743 (apportionment to resident trustees).

[4] Internal Revenue Code section 641; R&TC Section 17731, et seq.