When Can NJ Tax the Income of a Trust?

HNWEstate Administration and Probate, Understanding When a Trust Should Be Used in NJ

  • NJ trust lawI just finished reading statutes which address Tax Nexus and trusts, especially when a trustee administers a NJ trust for out-of-state beneficiaries.
  • I always emphasize the importance of definitions found in NJ statutes. Trust tax law definitions are key to understanding how and why a trust can be taxed in this state.

Definitions are Important Under NJ Trust Tax Laws

N.J.S.A. 54A:1-2(b) defines a “fiduciary as “a guardian, trustee, executor, administrator, receiver, conservator, or any person acting in a fiduciary capacity for any person.” This statute defines a “taxpayer” as “any individual, estate or trust required to report or pay taxes, interest and penalties under this act, or whose income in whole or in part is subject to the tax imposed by this act.”  New Jersey imposes tax on resident and non-resident taxpayers and resident and non-resident estates and trusts.

A “resident estate or trust” is defined as:

  • The estate of a decedent who at his death was domiciled in this state,
  • A trust, or portion of a trust, consisting of property transferred by will of a decedent who at his death was domiciled in this state, or
  • A trust, or portion of a trust, consisting of the property of:
    1. A person domiciled in this state at the time such property was transferred to a trust, if such trust or portion of a trust was then irrevocable, or if it was then revocable and has not subsequently become irrevocable; or
    2. A person domiciled in this state at the time such trust, or portion of a trust, became irrevocable, if it was revocable when such property was transferred to the trust but has subsequently become irrevocable.

For the purposes of the foregoing, a trust or portion of a trust is revocable if it is subject to a power, exercisable immediately or at any future time, to transfer ownership (title) back to the person whose property constitutes the trust or portion of a trust, or when the trust or portion of a trust becomes irrevocable and cannot be revoked or changed.

A “non-resident trust” is defined as a trust which is not a resident trust.

Note:  the definitions section also defines resident and non-resident taxpayers, but the definition of “resident taxpayer” refers specifically to individuals.

There are two important New Jersey cases on taxation of trusts.  They are Pennoyer v. Director, 5 N.J. Tax 386 (Tax 1983), and Potter v. Director, 5 N.J. Tax 399 (Tax 1983).  In both cases, the tax courts limited the ability of New Jersey’s Division of Revenue to tax trust income.  In both cases, the court looked at three things:  the location of the corpus of the trust, the location of the beneficiaries of the trust, and the location of the corporate trustee.  The court relief on the Due Process Clause of the 14th Amendment to hold that if none of the three are located in New Jersey, there is no tax nexus.

A problem occurs with trusts which are created in New Jersey.  Do they have sufficient nexus under New Jersey law to be taxed?  The test for constitutional due process for taxation of trusts reads:  “Constitutional due process requires a minimal link between the taxing state and the individual, property or transaction it seeks to tax, and also requires that a state grant some benefit to the taxpayer in return for the tax imposed.”  This is still the standard in New Jersey.  To avoid taxation, residuary beneficiaries of testamentary trusts need to (1) not reside in New Jersey, (2) have a trustee with no tax nexus to New Jersey, and (3) own no property in New Jersey.

New Jersey has a statute that addresses taxation for non-resident trusts as well, N.J.S.A. 54A:5-8.  It taxes income from sources within New Jersey.  It expressly includes non-resident trusts.  This is important for a non-resident trust which owns a business interest in New Jersey.  It states:

  1. Income from sources within this state for a non-resident individual, estate or trust means the gross income to the extent that it is earned, received or acquired from sources within this state:
    • By reason of ownership or disposition of any interest in real or tangible personal property in this state; or
    • In connection with a trade, profession, occupation carried on in this state or for the rendition of personal services performed in this state; or
    • As a distributive share of the income of an unincorporated business, profession, enterprise, undertaking or other activity as the result of work done, services rendered or other business activities conducted in this state except as allocated to another state pursuant to regulations promulgated by the director under this act; or
    • ) From intangible personal property employed in a trade, profession, occupation or business carried on in this state; or
    • As a result of any lottery or wagering transaction in this State other than that excluded from taxation pursuant to N.J.S.54A:6-11; or
    • As S corporation income allocated to this State of a New Jersey S corporation.

In a future post, I will address sources of income to a NJ resident trust/trust beneficiary which is not subject to tax.

If you are looking for additional details on this topic or if you require advice about your situation, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Trust Attorney

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