ABSTRACT

This Article provides a practical guide for legal practitioners who wish to use a non-grantor self-settled trust for the purpose of avoiding state income taxes imposed by high-tax jurisdictions on resident grantors. Although this Article is specific to California state income taxes and uses Nevada incomplete gift non-grantor trusts to illustrate the concept, the principles discussed are applicable to other jurisdictions. This Article addresses whether or not the state of California may come after the trust for the payment of state income taxes on those gains not yet distributed to the grantor-beneficiary.

I. Introduction

i. What Are Incomplete Gift Non-Grantor Trusts and Why Did California Create Legislation Limiting Their Operation?

Non-grantor trust status ensures the trust becomes its own taxpayer allowing the state income taxes to depend on the trust’s jurisdiction as opposed to the grantor’s residency.^[[1]] Incomplete gift non-grantor trusts (INGs) involve incomplete gift transfers so that the assets are included in the grantor’s gross estate (this is helpful in case the grantor wishes to retain access to and exercise control over the assets).^[[2]] As a result, a grantor domiciled in a state that imposes state income taxes can use the ING trust to hold assets that accumulate free of state income taxes  while allowing the grantor to retain a beneficial interest in the trust.^[2]

Given these considerations, the ING structure is especially lucrative for residents who live in states that impose high income taxes, such as California and New York. The jurisdiction of the ING trust itself can be done in any state that allows it, with Nevada (NING), Wyoming (WING), and Delaware (DING) being popular choices. For the purposes of this Article, the legal analysis will be specific to a California resident grantor and will assume that a Nevada ING is to be used to avoid state income taxes, however similar principles apply to other jurisdictions.

California recently enacted § 17082 of the California Revenue and Taxation Code in July 2023 in order to combat the use of INGs for the purpose of avoiding its’ state income taxes.^[[3]] The mechanism of § 17082 is to treat INGs as grantor trusts for state income tax purposes so that the income is taxed to the grantor (despite the trust technically being a non-grantor trust).^[[4]]

ii. What Are Self-Settled/Spendthrift Trusts and Why Would This Additional Factor, in Conjunction with the ING Structure, Pose Additional Issues in Circumventing California’s New Law?

Self-settled trusts, also known as spendthrift trusts, are those trusts where the grantor is also a beneficiary.^[[5]] Self-settled trusts intend to provide protection against the grantor-beneficiary’s creditors by rendering the assets inalienable by the beneficiary prior to distribution (in other words, if the assets are held in trust and not distributed, then the creditors should not be able to reach them).^[5] Self-settled trusts are often done in conjunction with the ING structure because individuals in high tax jurisdictions, such as California, are often also more exposed to creditor claims. As a result, the asset protection goals, and income tax considerations often go hand-in-hand.

In a similar vein to the benefits that an ING’s incomplete gift status grants, self-settled trusts allow the grantor to retain a beneficial interest by being directly named as the trust’s beneficiary. The self-settled ING trust structure poses additional issues in circumventing California’s new rule because the grantor is also a beneficiary, which is a factor that gives the state more reasoning to go after the trust for income tax purposes.^[[6]]

iii. This Article’s Research Goal

This Article will determine what structure, if any, may be used to shield the grantor from state income taxes while maximizing the grantor’s retention of interest in the trust. More specifically this will include an analysis of how the ING trust, the self-settled trust, or a trust that incorporates both features can function under current California law with the principle goal being to avoid the imposition of state income taxes on the trust and the secondary goal being creditor protection.

In terms of the state income tax considerations, this Article seeks to determine whether the state of California can come after a Nevada ING trust for the payment of California state income taxes if the grantor-beneficiary is a California resident. This analysis pertains to whether California can reach the assets of the ING trust, not whether California can go after the resident grantor personally for income taxes due as a result of trust distributions. In other words, this Article proceeds on the premise that the ING trust holds assets that the grantor does not require current access to; all growth within the trust shall remain outside the reach of the California state income tax until actual distributions are made to the grantor. This Article applies the same analysis to self-settled trusts and concludes with the relevant factors necessary to ensure the avoidance of state income taxes. Functionally, the guidelines presented by this Article allow the trust corpus to accumulate free of state income tax with the parties involved choosing when to trigger the tax (i.e., upon distribution). As a result, this remains a powerful wealth-maximizing structure for California residents despite the attempt of the recent enactment to foreclose on this possibility.

II. Introduction to the Federal Rules Governing Grantor Trust Status

Federal Tax Law states when the grantor retains certain powers over the trust so that the trust is a grantor trust, then all income is taxed to the grantor i.e. effectively the trust is treated as a pass-through entity (note that there are some exceptions to this rule, but these exceptions are not the focus of this Article).^[[7]]

The ING trust is an irrevocable non-grantor trust designed for the benefit of the grantor and other discretionary beneficiaries. However because the trust distributions are controlled by a trust distribution committee, which approves the distributions going to the grantor, the grantor retains sufficient control over the assets to be treated as not having made a completed gift, but at the same time, has insufficient control over the assets to be considered the owner for income tax purposes.^[[8]] Numerous private letter rulings confirm that ING trusts are non-grantor trusts for federal income tax purposes and are taxable trusts (not disregarded as pass-through entities).^[[9]] 

The bottom line is that ING trusts are non-grantor trusts for federal income purposes because the grantor does not retain powers that trigger grantor trust status. As a result, there is a mismatch between the treatment of INGs at the federal level and the state level where California and New York classify the trust as a grantor trust for state income tax purposes. This will be discussed in detail in the subsequent section.

III. The Mechanisms of California Revenue and Taxation Code § 17082 and New York Personal Income Tax Code § 612 as Pertaining to Incomplete Gift Status and State Policy Concerns

i. The Mechanism of California Revenue and Taxation Code § 17082

California’s recent law against INGs is codified in § 17082 of the California Revenue and Taxation Code. The specific language is as follows: (a) “the income of an incomplete gift non-grantor trust shall be included in a qualified taxpayer’s gross income to the extent [that the] … trust … were treated as a grantor trust under § 17731”.^[[10]] Subsection (d) defines “incomplete gift non-grantor trust” as a trust that meets both of the following: (A) “the trust does not qualify as a grantor trust under [26 U.S.C. § 671-679]” and (B) “the qualified taxpayer’s transfer of assets to the trust is treated as an incomplete gift under [I.R.C. § 2511]”.^[10] The term “qualified taxpayer” means a grantor of an incomplete gift non-grantor trust.^[10]

Since § 17082 treats INGs as grantor trusts for state income tax purposes, this makes the income taxed to the grantor (despite the trust technically being a non-grantor trust at the federal level).^[[11]] As a result, having the California resident grantor use a non-resident trustee (i.e. commercial domicile is out-of-state) is no longer sufficient to avoid California state income taxes under the new law. The statutory language indicates that the law does not reach completed gifts.^[[12]]

Given the mismatch between the state statute and federal law, California’s specific argument in opposition to non-grantor trust status for INGs is that the state reasons the grantor retains functional control through the distribution committee and uses the strategy to ensure that the trust is not disregarded but is instead taxed as a separate entity.^[[13]] In effect, the argument is that the ING structure allows grantors who retain control over their trust to be taxed differently relative to other grantors also retaining control over their trusts. This can be characterized as a policy argument based on the principle of fairness for those taxpayers who are “similarly situated.” The legal point that this hinges on appears to be the question of control; with the Franchise Tax Board implying that the same tax treatment should apply to grantors who “retain control over their trusts”, indicating that the choice of trustee may be largely irrelevant in such cases but is rather just motivated for tax purposes.^[13]

ii. New York Personal Income Tax Code § 612

Since California’s law is modeled upon New York’s § 612 governing resident individual’s gross income, enacted in 2014, an examination of § 612 may be informative as to how California’s rule applies.^[[14]]The specific language is as follows: “in the case of … an incomplete gift non-grantor trust, the income of the trust … to the extent such income and deductions of such trust would be taken into account in computing the taxpayer’s federal taxable income if such trust in its entirety were treated as a grantor trust for federal tax purposes”.^[[15]] As a result, the New York rule combats the ING trusts’ avoidance of state income taxes by adding the net income of an ING trust to the adjusted gross income of the resident individual, effectively taxing the trust as if it were a grantor trust.^[[16]]

iii. Incomplete Gift Status as a Key Factor Determinative of Whether the State Can Come After the ING for State Income Tax Purposes

To date, New York and California are the only two states with laws specifically targeting ING trusts that are used to avoid state income taxes.^[[17]] Since both California’s § 17082 and New York’s § 612 are specific as to the application for incomplete gifts only, the most conservative approach would be to structure the transfer to the trust as a completed gift; functionally averting the reach of the statute.

Could it be possible to avoid the reach of the state for income tax purposes if the transfer is an incomplete gift? Unfortunately, the answer appears to be no. Having a completed gift is crucial because this element is what justifies non-grantor tax treatment under both New York and California law. This is specifically in-line with both New York and California’s underlying policy concerns because since the control element is further reduced with completed gift status (i.e. a grantor making a completed gift loses sufficient control as to no longer be “similarly situated” relative to a grantor who only made an incomplete gift).^[[18]] Unfortunately this means losing out on the favorable gift and estate tax benefits associated with incomplete gifts.^[[19]]

IV. Will the State Respect a Self-Settled Trust as a Non-Grantor Trust for State Income Tax Purposes?

Where self-settled trusts have grantors who are also resident beneficiaries, the beneficiary aspect is an additional nexus that provides the state with a potential argument to make if coming after the trust for income taxes. This analysis is complicated by uncertainty surrounding whether California courts may gain jurisdiction over an out-of-state trust’s assets, especially as it implicates a state’s public policy concerns relative to Constitutional concerns.^[[20]] Much of the material on self-settled trusts in such situations pertains to asset protection, and although not directly applicable to the state income tax question, the analysis surrounding asset protection may be informative of the potential income tax consequences for self-settled trusts.

Broadly speaking, California courts may gain jurisdiction over an out-of-state trust’s assets if a substantial relationship exists between California and the trust at the time that the trust was created. This can exist if (i) the trustee is domiciled in California, (ii) the assets are located in California, or (iii) the beneficiaries are domiciled in California.^[[21]] On prong (iii), any distribution of income to a California beneficiary would be subject to California state income taxes but this is a settled issue.^[[22]] As to whether the beneficiaries’ domicile in California alone creates a sufficient relationship justifying the reach of California state income taxes onto the trust itself, aside from distributions, is an open question in terms of public policy and Constitutional concerns. In other words, this Article argues that if the California resident grantor-beneficiary is a contingent beneficiary, then the California residency does not alone give the state justification to come after the trust for income taxes.

A non-contingent beneficiary (also known as a “vested” interest) is defined as one whose interest is not subject to a condition precedent.^[[23]] A resident beneficiary will be deemed to hold a contingent interest in a trust when his or her ability to receive distributions from the trust is subject to the sole and absolute discretion of the trustee.^[[24]] He or she may be deemed to have a non-contingent interest in a trust if the trustee’s discretion is subject to a standard that the beneficiary can enforce.^[25] Between these two points exists more ambiguity, but for the purposes of this Article, these set the legal boundaries for what defines a contingent interest.^[[25]]

As a result, distributions subject to the “sole and absolute discretion” of a trustee are contingent interests under state law. Because a non-contingent beneficiary has a vested interest in the trust, he or she has a present right to receive distributions of the assets (currently or at a later date) and thus can be said to have control, possession, or enjoyment of the assets. As indicated above, if the trustee has complete discretion to allocate or distribute the assets of a trust, the beneficiary would have a contingent interest and therefore insufficient access to the trust assets. Accordingly, the trust assets would not be subject to California income tax based solely on the residence of the beneficiary.

To summarize, Nevada self-settled trusts seeking to avoid the imposition of state income taxes should (i) have a trustee domiciled in Nevada, (ii) not hold any California real property, and (iii) ensure that all California resident beneficiaries are contingent beneficiaries.

V. Does the Power to Distribute or Accumulate Income Result in Grantor Trust Status Jeopardizing this Article’s Proposed Structure in Terms of the Self-Settled Trust’s Ability to Avoid California State Income Taxes?

Federal tax law generally treats a grantor as the owner of a trust, for income tax purposes, under the grantor trust rules if he or she has retained an interest in the income from the trust.^[[26]^] The law treats the grantor as the owner of any portion of a trust in which the grantor and a non-adverse party, or both of them together, hold a power to do any of the following with respect to the income without the approval or consent of any adverse party: (i) distribute the income to the grantor or the grantor’s spouse; (ii) hold or accumulate the income for future distribution to the grantor or the grantor’s spouse; or (iii) apply the income to the payment of premiums on life insurance policies on the life of the grantor or the grantor’s spouse.^[27] As a result, grantor trust status automatically applies to any trust in which the grantor or his/her spouse is named as a beneficiary (i.e. a self-settled trust) if the independent trustee is a non-adverse party. In other words, if non-grantor tax treatment is to be upheld under § 677, then only an adverse party that is not a grantor may have the power to independently do (i)-(iii) above.^[27] Neither the grantor nor a non-adverse party to the grantor may hold such powers.^[[27]^] Although the goal of this memorandum is not the federal income tax system, state law often mirrors federal law, therefore despite California’s § 17082 being a notable departure from this pattern, this aspect of federal law may provide an argument for the state when it comes to justifying grantor tax treatment for self-settled trusts where the beneficiary is a California resident.

Although on its’ face this would seem to foreclose on the possibility of the grantor, either directly or indirectly, retaining an ability to distribute or accumulate the trust’s income, there is a way out through ensuring that non-grantor status is not jeopardized by the retention of such powers. The grantor may be a beneficiary to a non-grantor trust where the power to make any distribution to the grantor or to the grantor’s spouse or to accumulate income for a future distribution for their benefit is made in the sole discretion of trust beneficiaries other than the grantor or the grantor’s spouse (this is also known as a power of appointment committee or a “PAC”).^[[28]^]

As a recap to the interplay between this structure and California’s § 17082 and New York’s § 612, neither would apply given this Article’s recommendation that the self-settled trust consist of a completed gift (see the above discussion recalling that these state statutes only apply to “incomplete gift non-grantor trusts”). In terms of interaction with California state law generally (aside from § 17082), the trust’s assets would not be subject to state income taxes solely based on the beneficiary’s in-state residency as long as the fiduciary has complete discretion to allocate or distribute the assets of a trust; therefore making the beneficiary’s interest contingent.^[26^]

VI. Conclusion: Practical Guidelines for Avoiding California State Income Taxes through the use of a Non-Grantor Self-Settled Trust

In conclusion, the following factors should be present in order to avoid the reach of California state income taxes, both in terms of § 17082 and in terms of the  Constitutional and jurisdictional concerns for foreign self-settled trusts where the grantor-beneficiary is domiciled in the high tax jurisdiction: (i) the grantor makes a completed gift of assets to the trust, (ii) the trustee is a non-resident trustee, (iii) the assets are held in the “friendly” state (generally intangible assets such as stocks shall qualify as being held in the trust’s jurisdiction but this cannot be California real property), (iv) all California resident beneficiaries are contingent beneficiaries; meaning that their interest is subject to a condition precedent, and (v) the power to make any distribution to the grantor or to the grantor’s spouse or to accumulate income for a future distribution for their benefit is made in the sole discretion of a power of appointment committee (PAC).

Author Biography

Shanee Cohen is an accomplished attorney specializing in comprehensive wealth management and tax-advantaged estate planning. She graduated from the UCLA School of Law with a Juris Doctorate with a focus on taxation from the school’s esteemed business specialization program. Following her tenure at a renowned boutique law firm recognized for its expertise in high-net-worth international tax planning, Shanee founded her own practice, Cohen Consultancy PC. With nearly a decade of experience in transactional real estate, she specializes in tax-efficient structures, asset valuation discounting, and derivatives-based tax structuring projects for real estate family offices. Her holistic approach is designed to ensure the accelerated growth of wealth across generations, establishing her as a trusted advisor for family offices and high-net-worth individuals.

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[1] George D. Karibjanian & Hannah W. Mensch, State Income Tax Planning for the Nonresident Floridian: The Ing Trust, Fla. B.J., 2016, 58; Colin Korzec, Overview of Income Taxation of Non-grantor Trusts and Estates, MA-CLE, 2022, 4-1.

[2] Karibjanian & Mensch, supra note 1 at 58.

[3] Cal. Rev. & Tax. Code § 17082 (2023); Cal. Sen. S.B. 131 (2024 Reg. Sess.).

[4] Cal. Rev. & Tax. Code § 17082 (2023); Eric Bardwell, California Admits Incomplete Gift Non-Grantor Trusts Work … For Now, Bloomberg Tax, 2020; Price Waterhouse Coopers, New California Law Treats INGs as Grantor Trusts for State Income Tax, PWC, 2023. Originally beginning as “Legislative Proposal C,” the new law was codified when Governor Newsom signed Senate Bill 131 which added § 17082 to the California Revenue and Taxation Code. The new law is effective as of January 1, 2022. This law was modeled after a New York law that was effective in 2014. The new law does not affect an ING’s federal income tax treatment, so there can be mismatch issues with the state level.

[5] 90 C.J.S. Trusts § 26 (2024); 14 Massachusetts Practice, Trust Purposes – Spendthrift Provisions, § 17:26 (5^th ed. 2023); Black’s Law Dictionary, 10^th ed. (2014), p. 1747 defining “spendthrift trust” as a “trust that prohibits the beneficiary’s interest from being assigned and also prevents a creditor from attaching that interest.”

[6] The self-settled trust poses additional issues in circumventing California’s rule because the grantor is also a beneficiary, which is a factor that gives the state more reasoning to go after the trust for income tax purposes. The research here mostly centers on asset protection, and although not directly on-point to the state income tax considerations, remains persuasive authority relevant to the analysis in terms of the state’s jurisdictional reach. In simpler terms, if a state can reach the assets within the asset protection context, arguably this would also provide a justification for the applicability of income taxes. However, the articles and case law in this area were not definitive. See Cal. Prob. Code § 15304 for the proposition that generally California law does not permit assets to be transferred to an out-of-state trust where the income or principal is used for a resident grantor’s benefit while being protected from bankruptcy or creditor claims. Contrast this with Nev. Rev. Stat. § 166 which categorizes a self-settled Nevada trust as a separate entity from the settlor-beneficiary; therefore, preventing creditors from attaching to the trust’s assets. See Elizabeth Brickfield, Var Lordahl, & Matthew Policastro, The Myths and Realities of Nevada Self-Settled Asset Protection Trusts, Nevada Lawyer, 2015 at 11 (noting that “as long as settlors strictly comply with [Nevada’s] statutory requirements, they can name themselves as … beneficiaries and enjoy the same creditor protection as third-party beneficiaries of the trust). See Jacob Stein, The One-Two Punch: The Use of Trusts and LLCs In Asset Protection, California State University Northridge, page 4 (implying that although California strips the spendthrift protection of a trust when it is self-settled, other jurisdictions do not, thus forming an irrevocable trust in these other jurisdictions may preserve the protection; the discussion on California’s anti-merger statute also supports that the argument that reach of California state law can be avoided through the use of another jurisdiction).

[7] 26 U.S.C.A. § 671-9; Jesse Hubers, The Grantor Trust Rules: An Exploited Mismatch, The Tax Adviser, 2021; 1A Wisconsin Practice, Income Tax – Grantor Trusts, § 23:10 (5^th ed. 2023) stating that a “grantor trust” is a trust in which the person who establishes the trust—the settlor or grantor—retains certain interests and control, and because of this retention, is required to pay taxes on any income generated by the trust.

[8] Cal. FTB, Legislative Proposal C: Executive Summary, page 3 (stating that “within the ING trust structure, the trust maintains control over the assets and any distributions are controlled by the trust distribution committee … [which] approves the distributions that the grantor receives [therefore] the grantor retains sufficient control over the assets to be treated as not having made a completed gift … [but also] being treated as having retained insufficient control over the assets to be considered the owner of the assets for income tax purposes”).

[9] I.R.S. Priv. Ltr. Rul. 2016-36-029 (May 2016); I.R.S. Priv. Ltr. Rul. ­2016-36-032 (May 2016); I.R.S. Priv. Ltr. Rul. 2016-50-005 (August 2016); I.R.S. Priv. Ltr. Rul. 2016-36-027 (September 2016); I.R.S. Priv. Ltr. Rul. 2016-36-028 (September 2016); Charles McWilliams, Constitutional Challenges to State Taxation of Non-Grantor Trusts, ACTEC Foundation, pages 6-8.

[10] Cal. Rev. & Tax. Code § 17082 (2023); Cal. Sen. S.B. 131 (2024 Reg. Sess.).

[11] Korzec, supra note 1 at 4-1, Cal. Rev. & Tax. Code § 17082 (2023); Bardwell; Price Waterhouse Coopers, supra note 4.

[12] Cal. Rev. & Tax. Code § 17082 (2023).

[13] Cal. FTB, Legislative Proposal C: Executive Summary, pages 2 and 5 (stating that “California is unable to require the same tax treatment for grantors with in-state and out of state trustees that retain control over their trusts” where the California resident grantor can simply utilize an ING trust in a jurisdiction that does not have a state income tax in conjunction with an out-of-state trustee to avoid California state income taxes. The underlying policy consideration the law addresses is to result in the trust income being included in the grantor’s income as opposed to hinging on the trust’s jurisdiction or the residency of the trustee).

[14] Cal. FTB, Legislative Proposal C: Executive Summary, page 5 (stating that “New York previously identified this same issue … [and] this proposal recommends amending the California PITL in a manner similar to the statute amendments made by the State of New York [where] … New York added the net income of an ING trust to the adjusted gross income of the New York resident individual, as if the trust was a grantor trust … [as to effectively tax] income from New York resident grantor ING trusts”; see generally the New York State Bar, 2014 Changes to New York’s Estate, Gift, and Trust Income Taxes (Revised), 2015.

[15] N.Y. Tax Law § 612, specifically see (41): “in the case of … an incomplete gift non-grantor trust, the income of the trust … to the extent such income and deductions of such trust would be taken into account in computing the taxpayer’s federal taxable income if such trust in its entirety were treated as a grantor trust for federal tax purposes”. For purposes of this paragraph, an “incomplete gift non-grantor trust” means a resident trust that meets the following conditions: (i) the trust does not qualify as a grantor trust under section six hundred seventy-one through six hundred seventy-nine of the internal revenue code, and (2) the grantor’s transfer of assets to the trust is treated as an incomplete gift under section twenty-five hundred eleven of the internal revenue code, and the regulations thereunder.

[16] N.Y. Tax Law § 612; New York State Bar, 2014 Changes to New York’s Estate, Gift, and Trust Income Taxes (Revised), 2015, page 5 (stating that “an ING Trust, referred to above, is an incomplete gift non-grantor trust created by a New York taxpayer in another state to avoid New York income tax on the income and gains from the assets transferred to the trust without current gift tax liability. Under the Executive Budget, effective immediately for tax years beginning on or after January 1, 2014, but excluding income earned by ING Trusts that are liquidated before June 1, 2014, an ING Trust created by a New York taxpayer will be treated as a grantor trust for New York purposes. As a result, the New York taxpayer who had been trying to avoid the New York tax will now be required to pick up all of the trust’s income on her income tax return. This, in turn, will cause a disconnect between the New York state and federal reporting with the same trust, for federal tax purposes, continuing to report the income as derived from a non-grantor Trust”).

[17] Price Waterhouse Coopers, New California Law Treats INGs as Grantor Trusts for State Income Tax, PWC, 2023.

[18] Cal. FTB, Legislative Proposal C: Executive Summary, page 3 (stating that “within the ING trust structure … the grantor retains sufficient control over the assets to be treated as not having made a completed gift”).

[19] Id. (stating that when an incomplete gift is made to a trust, the grantor need not use any lifetime estate tax exemption or incur any federal gift tax liability); Outwin v Commissioner, 76 T.C. 153, citing 153, 162, and 169, 1981 (holding that having a friendly trustee does not prevent a gift from being complete due to the grantor retaining too much control where the trustee has absolute and sole discretion; however note that this case held that the grantors failed to relinquish sufficient control since under the applicable state law the grantor’s creditors could reach the trust’s assets).

[20] See generally, Jacob Stein, The One-Two Punch: The Use of Trusts and LLCs In Asset Protection, California State University Northridge.

[21] Jacob Stein, The One-Two Punch: The Use of Trusts and LLCs In Asset Protection, California State University Northridge, page 7 (note that most negative treatment in this regard pertains to cases where the trust held real property in California. This alone is sufficient to make the applicable governing law California, regardless of whether the trust itself is in a different jurisdiction, inclusive of self-settled trusts. As a result, if the trust holds California real property, this structure will not work for the avoidance of state income taxes); also pertaining to California real property, this conclusion appears to be fixed. Although business interests, such as LLC shares, are considered to be intangible, even if the taxpayer used a foreign entity to hold California real property, it would still be liable for the state’s property taxes. Since the state is already able to impose property taxes, there does not appear to be a convincing argument as to why it would not be able to impose income taxes especially since the income itself derives from the state of California. Lastly, for purposes of liability protection, a foreign business entity would still have to register with the state of California and would thus be subject to all applicable associated fees.

[22]  Cal. FTB, Filing Situations: Estates and Trusts, (discussing income taxes due for distributions made to California resident beneficiaries); Cal. FTB, Legislative Proposal C: Executive Summary, page 3 (stating that the distribution from the non-grantor trust to its beneficiaries is subject to tax); 2014-15 New York State Executive Budget, Revenue Article VII Legislation: Memorandum in Support, 2014, page 4 (pertaining to the proposal to tax resident beneficiaries on distributions of the trust’s accumulated income when received by the resident beneficiaries); Charles McWilliams, Constitutional Challenges to State Taxation of Non-Grantor Trusts, ACTEC Foundation, page 15 (noting that the state may tax the undistributed income of a trust based on the presence of an in-state trustee with the justification being the state giving the trustee the protection of its law, which are the same benefits provided to a non-contingent resident beneficiary); McCulloch v. Franchise Tax Board, 61 Cal. 2d 186, 192-4, 1964 (holding that a discretionary trust’s terminal distribution of accumulated income is subject to California state income tax solely because of the beneficiaries’ California residence; this established sufficient contract between the trust and the state for it to be subject to the tax). However note that although the case establishes that California can constitutionally tax the beneficiary at the time he receives the income as a distribution, it remains silent as to whether it can tax the trust itself, thus this does not specifically answer our question presented in this memorandum and is merely supportive of the notion that the beneficiaries’ residence may be sufficient contact for income tax purposes; Cal. FTB, 2017 Instructions for Form FTB 5870A: Tax on Accumulation Distribution of Trusts, 2017 (stating: “Although California conforms to the federal provision repealing the throwback rules, California may still apply R&TC Section 17745(b). This provision states that if the trust did not pay tax on current or accumulated income of the trust because the resident beneficiary’s interest in the trust was contingent, this income will be taxable when it is distributed or distributable to the beneficiary. For any taxable year in which an otherwise contingent beneficiary receives a distribution, the beneficiary is non-contingent to the extent of the distribution, and the trust may have a filing requirement under R&TC Section 18505 for that taxable year. Get the instructions for Form 541, California Fiduciary Income Tax Return, for more information”; Cal. FTB, T.A.M. 2006-0002, 2006 (in summary, a resident beneficiary of a discretionary trust has a non-contingent, vested interest in the trust as of the time, and to the extent of the amount of income the trustee decides to distribute). These sources confirm this paper’s analysis on distributions, indicating that functionally the contingent beneficiary prong can be used by legal practitioners to allow the trust to “delay” the imposition of state income taxes.

[23] 18 Cal. Code Regs. §17742(b) (stating that a non-contingent beneficiary’s interest is not subject to a condition precedent therefore the beneficiary has a vested interest); Bardwell, supra note 4.

[24] Cal. FTB TAM 2006-0002 (Feb 17, 2006), N.C. Dep’t of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, 588 U.S., n.10 (2019) (citing Fondren v. Commissioner, 324 U.S. 18, 21 (1945)). Specifically see Kaestner for the proposition that a trust’s non-distributed capital gains remaining in the trust (i.e. undistributed to the resident-beneficiary) should remain out of reach of that resident-beneficiary’s state for income tax purposes where such distributions are permissible, but not mandatory (i.e. the resident-beneficiary’s interest is contingent).

[25] Bardwell, supra note 4. Specifically note the following: “the second prong of California’s system of trust taxation looks at the residence of every non-contingent beneficiary of the trust. A non-contingent beneficiary is a beneficiary whose interest is not subject to a condition precedent. Although the term” condition precedent“is not defined in either the statute or the regulations, the FTB has provided the following definition: an act or event, other than a lapse of time, that must exist or occur before a duty to perform something promised arises. If the condition does not occur and is not excused, the promised performance need not be rendered. The most common condition contemplated by this phrase is the immediate or unconditional duty to performance by a promisor. The FTB has determined that, in the case of a fully discretionary trust, a resident beneficiary who receives no distributions during the tax year is a contingent beneficiary. In the event a distribution is made to a resident beneficiary from a fully discretionary trust, the beneficiary becomes a non-contingent beneficiary, but only with respect to the amount so distributed. It is less clear whether a beneficiary of a discretionary support trust, where the fiduciary has the discretion to distribute income and/or principal to a beneficiary for his or her health, maintenance, education, and support, would be considered a contingent beneficiary. The additional limitations imposed by an ascertainable standard coupled with fiduciary discretion should, in theory, render a beneficiary’s interest contingent as it places a greater restriction on a fiduciaries ability to make a distribution to a beneficiary. While some commentators have suggested that a beneficiary of such a trust would indeed be considered a contingent beneficiary, others have argued that the use of an ascertainable standard would create an enforceable right in the beneficiary or his or her creditor to compel a distribution, which in turn would cause the beneficiary to be treated as non-contingent”.

[26] I.R.C. § 677(a); Treas. Reg. § 1.677(a)-1.

[27] I.R.C. § 677(a); Treas. Reg. § 1.677(a)-1.; I.R.C. § 672(a) (defines adverse party as a person with a “substantial beneficial interest in the trust which would be adversely affected by the exercise or non-exercise of the power which he possesses respecting the trust” and that “a trustee is not an adverse party merely because of his interest as trustee”).

[28] I.R.S. Priv. Ltr. Rul. 2014-36-008 (December 2013) and I.R.S. Priv. Ltr. Rul. 2015-50-005 (August 2015) (for indicating that the beneficiaries who are not the grantor or the grantor’s spouse, when deciding upon any distributions made to the grantor or to the grantor’s spouse, are sometimes termed the power of appointment committee (PAC). The PAC may make a decision by majority vote with the grantor’s consent or by unanimous vote without such consent. As to distributions to beneficiaries who are not the grantor or the grantor’s spouse, these can be made by a non-adverse trustee without triggering grantor trust status); Charles Fox, Recent Developments in Estate Planning and Estate and Trust Administration, Southern Arizona Estate Planning Council, 2018, pages A-25-6 and B-11–2; citing Private Letter Rulings 2014-10-001–2014-10-010,  2017-44-006, and 2017-44-007 (mentioning the Service explicitly stating that “with respect to [the trust’s non-grantor status for income tax purposes] … the Service, as it has in previous rulings dealing with income tax consequences of incomplete non-grantor trusts, ruled that the grantor would not be treated as an owner of the trust under Sections 673, 674, 676, 677, or 679 so long as the trust remained a domestic trust and the Power of Appointment Committee remained in existence”. It should be noted that the powers held by the committee members were not taxable general powers of appointment so that incomplete gift status could be retained with the use of the PAC, however for this Article’s purpose in avoiding the reach of state income taxes by using complete gift status, this would not be of much benefit); I.R.S. Priv. Ltr. Rul. 2019-25-009 (December 2018) and I.R.S. Priv. Ltr. Rul. 2020-14-002(August 2019) (citing both where both quote that “as long as Trust is a domestic trust and the [Power of Appointment] Committee remains in existence and serving” … then pertaining to the powers of distribution or accumulation, the grantor will not “be treated as the owner of any portion of Trust under § 673, 674, 676, 677, or 679”).