Residuary Trust A U/W/O Kassner v. Dir., Div. of Taxation, App. Div:

An Overview of the Residuary Trust Landscape

Presented By:

Michael L. Salad

Facts

• Fred E. Kassner, a New Jersey resident and domiciliary, died in 1998

• His will created a resident testamentary trust (Trust A)

• Trustee was a New York resident and administered Trust A outside of New Jersey

• Trust A owned S-Corporation stock

Facts

• Trust A filed a 2006 Form NJ-1041

• Trust A paid tax on:

– The net pro rata share of S-Corporation income allocated to New Jersey

• No distribution made to beneficiaries in 2006

Facts

• N.J. audit assessed a deficiency in tax liability

• The New Jersey Division of Taxation determined 100% of undistributed income was taxable, including income outside of New Jersey

Issues:

• May N.J. properly tax undistributed income derived from a testamentary trust?

• Does ownership of stock in a N.J. S-Corp constitute ownership of N.J. assets?

Applicable N.J. Laws

• The Act imposes taxes on the New Jersey gross income of all individuals, estates or trusts. N.J.S.A. 54A:2–1.

• N.J.S.A. 54A:5–1(h) includes in New Jersey gross income the “net gains or income derived through estates or trusts.”

• N.J.S.A. 54A:5–3 taxes “income or gains of the estate or trust ... which has not been distributed or credited to its beneficiaries.”

Argument #1

• Director contended that 100% of the undistributed income of Trust A was taxable pursuant to the New Jersey Gross Income Tax Act

• Director cited District of Columbia v. Chase Manhattan Bank and Chase Manhattan Bank v. Gavin

Ruling 1

• Tax court cited Potter v. Taxation Div. Dir. And Pennoyer v. Dir. Div. Taxation

• New Jersey is barred from jurisdiction when there is a lack of sufficient contacts in the state

• Trust was not administered in N.J.

Argument #2

• Director believes that Trust A must report New Jersey pro rata share of S Corporation income as New Jersey income

• Director cited N.J.S.A. 54A:5-10 and N.J.A.C. 18:35-1.5(d)(5)(i) through (ii)

Ruling

• Tax court cited 26 U.S.C.A.§1361(a)(1) and the Pennoyer ruling

• Final ruling held that the Director incorrectly conflated taxation with ownership of assets

Ruling

• An S-Corporation elects to pass its income through to its shareholders who are subject to taxation thereon

• No mention of transfer of ownership of assets from the corporation to the shareholder

• The owner of the stock in an S-Corporation does not own or hold title to the assets

Appellate Ruling

• Affirmed the ruling by the Tax Court

• Cited Division’s Official Guidance

• Refused to hear new arguments

Planning Techniques

• Unconstitutional to tax a trust based solely on the settlor’s residency

• Increasingly more common for trustees, beneficiaries and assets to be mobile

• Importance in considering new or additional state income tax rulings and changes in residency of trustees, beneficiaries, and location of assets