We live in an age of unparalleled mobility in a world of many differing taxes and taxation structures. Yet permanently changing one’s residence is not a decision lightly made. Wealth can grow more quickly in states without an income tax through nongrantor trusts. These are trusts created at the cost of surrendering grantor control, and in return for that loss of control, the grantor is not taxed on the income of such a trust. The trust is taxed instead based on the trust’s residence—permitting a grantor to live in a state with a heavy tax burden while their assets grow in a state with a light tax burden. Recently, California disrupted this strategy by enacting SB 131.
In addition to ceding control, another price for creating a nongrantor trust is the gift tax liability usually incurred through transferring assets to it. Like a nongrantor trust, the gifter’s lack of control is a prerequisite for creating a gift. Yet the standard for a gift is stricter than for a nongrantor trust. It is possible to retain enough power to disqualify the transfer as a gift but not enough to disqualify the trust as a nongrantor trust. The result in the past was a trust that can be funded without gift tax liability while earning income without being taxed at the state level, an ING. Under the new regulations the grantor of an ING will now be taxed on the ING’s income by California.
A grantor of an ING will be taxed on all of the ING’s income beginning with the 2023 tax year. This is true regardless of the ING’s creation date. It is not limited to grantors living in California either. A nonresident grantor will be taxed on the ING’s California-sourced income even if the grantor lacked contact with California. This law was likely inspired by New York, which enacted a similar law in 2014 without a legal challenge. The Franchise Tax Board estimated that a substantially similar law would increase the annual tax burden by an approximate average of $24,000 per affected taxpayer.
If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.
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California has required employers to “indemnify” employees for “necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer” in substantially the same terms since 1937 under Labor Code § 2802.
