Taxation of Estates & Trusts in NJ and Residuary Trust A v. Director

Taxation of Estates & Trusts in NJ and Residuary Trust A v. Director

Estates and trusts are subject to New Jersey gross income tax...

Charitable trusts and trusts that form part of a pension or profit-sharing plan are expressly exempted from the gross income tax.

Estate and trust income is taxed only once by New Jersey, either at the estate or trust level, or at the beneficiary level. If an estate or trust is required to distribute gross income on a current basis, or if its gross income is in fact paid or credited currently to a beneficiary, the tax burden with respect to that gross income is shifted from the estate or trust to the beneficiary. If current income is not distributed or credited to the beneficiary, the income or gain is taxable to the estate or trust.

...

Gross income of an estate or trust consists of the sum of the income categories specified in the Gross Income Tax Act. Some of the income categories specified in the Act include remuneration received for services rendered, net profits from business, net gains or income from disposition of property, interest, and dividends.

...

In Residuary Trust A v. Director, 27 N.J. Tax 68 (Tax Ct. 2013), the New Jersey Tax Court held that the state of New Jersey could not tax the undistributed income of a testamentary trust because the trust at issue did not have sufficient contacts to the state. The January 2013 case presents an opportunity to look at what constitutes "sufficient contacts" within the state of New Jersey for purposes of properly taxing the undistributed income of a testamentary trust.

As described by the court, the trust at issue (referred to in the case as "Trust A") was created by the will of the decedent, a domiciliary of New Jersey who died in 1998, for his descendants' benefit. The resident trust was administered completely outside of New Jersey by the sole trustee, a resident of New York, from the beginning of 2006 and throughout that year. As noted by the court in a footnote, a "resident trust" is defined by N.J. Stat § 54A:1-2(o)(2) of the New Jersey statutes as "[a] trust, or portion of a trust, consisting of property transferred by will of the decedent who at his death was domiciled in [New Jersey]."

...

The tax court identified the following two primary issues in the case as:

  1. whether New Jersey could properly tax the undistributed income of the testamentary trust; and
  2. whether ownership of stock in a New Jersey S corporation constituted ownership of New Jersey assets.

As to the first issue, the court determined that it has been "long recognized" by the courts and the Division of Taxation that there are limits on the state's authority to tax the undistributed income of resident trusts with insufficient contacts with the state.

...

With respect to the second issue identified by the Residuary Trust court – whether the trust assets were located in New Jersey – the court held that the trust could not be deemed to own assets in the state just because it held shares in S corporations owning New Jersey assets. The court rejected the Director's argument, based upon the flow-through nature of S corporations, that the trust could be treated as owning the assets of the S corporations. The court concluded that that the Director "incorrectly conflate[d] pass-through taxation with ownership of underlying assets." 85 The court determined that the applicable statute, 26 U.S.C.S. 1361(a)(1), makes "no mention of any transfer of ownership of the underlying assets from the corporation to the shareholders" and concluded that "[t]herefore, the owner of stock in an S corporation does not own or hold title to the underlying assets of the corporation."...

...

The court concluded that the trust did not have sufficient contacts to New Jersey for the state to tax its undistributed income from sources outside the state and held that the trust did not owe taxes on the interest income earned in 2006." ...

In summary, as stated by the Residuary Trust court in its analysis, the New Jersey courts and the Division of Taxation have "long recognized" the limits on the state's power to tax the undistributed income of a resident trust that does not have sufficient contacts with the state. The Residuary Trust opinion falls in line with that rule of law and also clearly indicates the New Jersey Tax Court's adherence to its holdings in Pennoyer and Potter that the due process requirement of the Fourteenth Amendment prohibits the state from taxing the undistributed income of a trustee, assets, and beneficiaries are located outside of the state.In addition, the Residuary Trust opinion provides the rule of law that a trust will not be deemed to own assets in New Jersey based merely on its status as a shareholder in a S corporation that owns New Jersey assets.

...

LEXIS users can view the complete commentary HERE. Additional fees may apply. (Approx. 21 pages)

Discover the features and benefits of LexisNexis® Tax Center

For quality Tax & Accounting research resources, visit the LexisNexis® Store