Planning for Life

Is Your Trust Subject to Massachusetts Income Tax?

Posted by Harry S. Margolis on November 8, 2016

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By Harry S. Margolis

Is your trust subject to Massachusetts income taxes? Probably it is. But probably it also pays no income tax so it doesn't matter. I'll explain the reasons why below.

In contrast, the 35 trusts in question in the case of Bank of America, N.A., vs. Commissioner of Revenue (SJC-11995, July 11, 2016), do have to pay income taxes. The Bank of America argued that when it acts as trustee its trusts should not be subject to Massachusetts income tax because (1) as a corporation it's not a "natural person" and (2) it doesn't have sufficient nexus with Massachusetts to be considered an "inhabitant" of the state for this purpose. The Massachusetts Supreme Judicial Court in this decision disagrees, upholding the decision of the Appellate Tax Board to tax the income of these trusts.

Bank of America is a Massachusetts Inhabitant for Tax Purposes

On the first argument, the Court finds that the statute talking about taxing a "natural person" didnursing_home_couple.jpg not change a prior statute taxing corporations. If the legislature had wanted to relieve corporations of taxation, the Court rules, it could have changed the preexisting statute, but it chose not to do so. The Court further rules that the Bank of America is an inhabitant of Massachusetts for purposes of taxation,despite the fact that its corporate headquarters are in Charlotte, North Carolina, because of its 200 branches in the state and the fact that office and staff administering these trusts are also in Massachusetts.

Unfortunately for the Bank of America, its corporate history is undoubtedly its undoing. They bought Fleet which had bought Bank of Boston which had bought Bay Bank. (It sounds a bit biblical if we replace "bought" with "begat.") Bank of Boston had a storied trust department and Bay Bank had a large network of branches. On a political note, while it may have no legal relevance, it's a bit inconsistent for corporate America to argue to the Supreme Court in Citizens United that it should have the First Amendment rights of natural persons but to Massachusetts' highest court that it should not be taxed like a natural person.

Politics aside, the consequence of this decision is that if you have a taxable trust and want to avoid taxation of income in Massachusetts, you should choose a clearly non-Massachusetts trustee. Not surprisingly, it was a New Hampshire bank that brought this case to our attention.

But Why This Probably Does Not Affect Your Trust

For most readers of this blog, this decision will be irrelevant for two reasons: First, if one or more of the trustees are Massachusetts residents, the trust will be subject to Massachusetts taxation. You would have to make sure that no trustee has ties to Massachusetts to avoid the tax jurisdiction of the state. But the more important reason that the decision probably does not apply to you is that most trusts don't pay taxes on income. For revocable trusts, taxes are paid by the grantor. For most irrevocable trusts, taxes are paid by the beneficiaries who receive the income. Trusts only pay tax on income they retain, in most cases larger trusts where the beneficiaries don't need the income.

Irrevocable trusts have a separate tax identification number and must file income tax returns reporting their income. But if the income has been distributed during the year, the trust deducts on the returns it files and K-1s to the beneficiaries giving them the information they need to report on their personal income tax returns.

If you have or are considering creating and funding an irrevocable trust which does not or will not distribute all of its income each year, this decision may be a reason to consider an out-of-state trustee, avoiding the 5.1% Massachusetts income tax. Please feel free to get in touch with us to discuss this or related trust issues.

Topics: trusts, income taxes

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