On July 10, 2023 California Governor Gavin Newsom approved Infrastructure and Budget Legislation. The bill, SB 131, relates to taxation and includes several amendments to the Government Code, Revenue and Taxation Code, and Welfare and Institutions Code and thus changes the law in California to cause income in INCOMPLETE non-grantor trusts to be counted as California income. Importantly, the new law is limited to non-grantor trusts that are “incomplete” for gift and estate tax purposes. The law does not apply to COMPLETED GIFT non-grantor trusts.

California clients with Incomplete Grantor Trusts: It’s time to replan. 

Here’s what you need to know. 

• Estates and trusts under the current Personal Income Tax Law are subject to taxation on their taxable income, similar to individuals. This is true under both state and federal tax law.  If a trust is classified as a “grantor trust,” where the grantor or another individual is treated as the owner of a portion of the trust, then the trust’s income, deductions, and tax credits are included in the grantor’s taxable income. The grantor will report the trust’s income on his or her personal income tax return and will be responsible for payment of tax liability.
• The proposed bill is RETROACTIVE taking effect on January 1, 2023, and would include the income of an “incomplete gift nongrantor trust” in the gross income of the grantor. This means that if the trust’s income would have been considered in the grantor’s taxable income had it been treated as a grantor trust, it will now be included in the grantor’s gross income.
• However, certain conditions can exempt a trust from this provision, such as the fiduciary making an irrevocable election to be taxed as a resident nongrantor trust, as specified in the bill.

Starting from January 1, 2023, the new Section 17082 is added to the Revenue and Taxation Code, which outlines the treatment of income from an incomplete gift nongrantor trust for qualified taxpayers.

More specifically…

• For taxable years beginning on or after January 1, 2023, the income of an incomplete gift nongrantor trust will be included in the gross income of a qualified taxpayer. The inclusion will be to the extent that the trust’s income would have been considered in the taxpayer’s taxable income if the extent of the trust were treated as a grantor trust under Section 17731.
• There is an exception to the income inclusion. The income of an incomplete gift nongrantor trust will not be included in a qualified taxpayer’s gross income if the following conditions are met: 

1. 1. The fiduciary of the trust files a timely original California Fiduciary Income Tax Return and makes an irrevocable election to be taxed as a resident nongrantor trust under Chapter 9 (starting from Section 17731). This election must be made using the prescribed form and manner by the Franchise Tax Board.
   2. The incomplete gift nongrantor trust is considered a nongrantor trust according to Chapter 9 (starting from Section 17731), which in essence follows the Federal rules.
   3. At least ninety percent of the distributable net income of the incomplete gift nongrantor trust, as per Chapter 9 (starting from Section 17731), is distributed or treated as being distributed to a charitable organization defined under Section 501(c)(3) of the Internal Revenue Code. This includes provisions like Section 17752 or 17731(a) within Chapter 9 (starting from Section 17731).

Definitions for the Infrastructure and Budget Legislation SB 131 Bill

“Incomplete gift nongrantor trust” refers to a trust that meets two conditions: (A) It doesn’t qualify as a grantor trust as defined by Subpart E of Part I of Subchapter J of Chapter 1 of Subtitle A of the Internal Revenue Code. (B) The transfer of assets to the trust by the qualified taxpayer is treated as an incomplete gift under Section 2511 of the Internal Revenue Code concerning transfers in general.

“Qualified taxpayer” means the grantor of an incomplete gift nongrantor trust.

“Resident nongrantor trust” means a trust that is not a grantor trust and where the tax applies to the entire taxable income of the trust based on the residency of the fiduciary or beneficiary as per Section 17742.

California clients: reach out to your Bespoke contact immediately to connect you with a trusted colleague. Those based in California who are interested in Incomplete Non-Grantor Trusts reach out to a Bespoke team member for more information.  

This information is intended for general educational purposes only and should not be construed as legal or investment advice.