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Bank of America v Commissioner: The State Seizes the Upper Hand on the Income Taxation of Trusts

Bank of America v Commissioner: The State Seizes the Upper Hand on the Income Taxation of Trusts

What determines a non-grantor trust’s residence for income tax purposes? Is it the state where the testator resides that matters? Do we look to the state the trustee inhabits? Is the residence of the beneficiaries a factor? The Massachusetts Supreme Judicial Court recently weighed in on this question in a case that could dramatically impact the taxation of trusts in numerous states across the country.

What the court affirmed was that an out-of-state bank acting as a corporate fiduciary of an inter vivos trust was a statutorily defined “inhabitant” of Massachusetts based on the bank’s presence and trust-related activities in the Commonwealth. The purpose of this article is to explain how this seemingly mundane decision could have adverse tax consequences for unsuspecting taxpayers both inside and outside of Massachusetts.

Basic Concepts in the Taxation of Trusts

In order to grasp the full import of the Massachusetts Supreme Judicial Court’s recent decision, having an understanding of the fiduciary income taxing states’ definition of a residence trust is essential. Each such state has its own version. The definitions are typically based on at least one or more of the following characteristics: the residence of the grantor, the residency of the beneficiaries, or the domicile of the fiduciary.

Whether a trust falls under a state’s definition of a resident determines how much of the trust’s income will be subject to the state’s income tax. A trust generally pays tax to its resident state on all taxable income derived anywhere in the world that is not distributed out to its beneficiaries. A nonresident trust, however, generally pays income tax only to the states in which accumulated income is sourced.

While a state may write its own income tax code, the degree to which it has jurisdiction to tax a trust’s income is limited by more supreme law, namely the United States Constitution’s Due Process and Commerce clauses. Two landmark court cases defining these constitutional constraints are Complete Auto Body Transit, Inc. v Brady, 430 U.S. 274 (1977) and Quill Corporation v. North Dakota, 504 U.S. 298 (1992). Satisfying the requirements of these constitutional provisions requires certain nexus and interstate commerce standards be met. On July 11, 2016, the Massachusetts Supreme Judicial Court waded into the aforementioned statutory and constitutional morass in the case of Bank of America, N.A. v. Commissioner of Revenue, 474 Mass. 702 (2016).

Bank of America v. Commissioner of Revenue

The issue in the Bank of America (“BOA”) case was whether BOA, acting as a corporate trustee of certain inter vivos trusts, was a statutorily defined “inhabitant” of the Commonwealth, thus subjecting the trusts to the taxing jurisdiction of Massachusetts.

Section 10(c) of G.L. c. 62 of the Massachusetts code provides an inter vivos trust is subject to the taxing jurisdiction of Massachusetts if it has at least one trustee who is an inhabitant of the Commonwealth and a grantor that: (1) was a Massachusetts inhabitant when the trust was created; (2) resided in Massachusetts during any part of the tax year for which the income is computed; or (3) died a Massachusetts inhabitant.

Under G.L. c. 62, § 1(f), a trustee who is not domiciled in the Commonwealth is deemed an inhabitant or resident if the fiduciary is a natural person who maintains a permanent place of abode in Massachusetts and spends in the aggregate more than one hundred eighty-three days of the taxable year in the Commonwealth.

BOA is a national banking association whose commercial domicile and principal place of business is in North Carolina. In Massachusetts BOA engaged in three categories of activities: (1) general commercial activities; (2) activities related to BOA’s trust administration business generally; and (3) material trust administration activities relating specifically to the trusts at issue. Examples of the specific trust activities included operating and staffing offices to fulfill the bank’s trustee obligations; maintaining relationships with the trusts’ beneficiaries; administering the trusts’ assets, conducting research on tax issues relating to the trusts; and discussing trust related issues with grantors, beneficiaries and/or their representatives.

By its terms § 1(f) refers only to a “natural person,” a term that does not include a corporation. However, by assuming § 1(f) was intended to apply to entities too the court determined that BOA was an inhabitant of the Commonwealth by mainly focusing on the trustee’s specific trust related activities conducted in Massachusetts. As a result, the inter vivos trusts were subject to tax as residents of Massachusetts even though they had a corporate trustee domiciled elsewhere. It should be noted, BOA conducts its banking services in countless states throughout the country. Whether the outcome of the case comports with the Commerce Clause requirements of the United States Constitution was not addressed due to a technicality.

The Court’s ruling raises several questions. They include: To what extent are we likely to see the state actions of the government in the BOA case replicated in other states? Would the outcome of the BOA case have been different had the constitutionality of the Commonwealth’s position been considered? What are the potential tax consequences today for a trust using a corporate trustee that operates in many states? Can a corporate trustee limit its client’s multi-jurisdictional tax exposure by performing most of its specific trust related duties, remotely, from its state of domicile?

In the wake of the BOA case, understanding how a state will determine the residency status of a trust is critically important. Please contact your local Withum advisor if you have any questions about the tax implications to you of the recent BOA decision.

Ask Our Experts

Marcus Dyer, CPA, ESQ
T (609) 945 79.6
mdyermdyer@withum.com

bhorowitz@withum.com

To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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