USA – NEW YORK Law and Practice Contributed by: John M Teitler, Nancy A Murphy and Constance E Shields, Teitler & Teitler LLP
New York Under New York law, the income tax classification of trusts follows the federal rules, but there are some state specific rules for residency and source of income. Resident trust rules Under New York tax laws, a resident trust is income taxable in New York and is generally created by a donor who is domiciled in New York when the trust becomes irrevocable. However, resident trusts may qualify for an exemption from New York income tax if certain conditions are fulfilled, including: • all the trustees are located outside New York; • all trust property is located outside New York; and • the trust has no New York source income. Accordingly, the appointment of a New York resident trustee may affect the taxation of a trust. The mere fact that a beneficiary or donor also serves as a fiduciary does not, by itself, create adverse tax consequences under either federal or New York law. Rather, tax consequences arise from the scope of the fiduciary’s powers, the degree of retained control, and, for New York purposes, factors such as trustee residency, trust situs and New York source income. In practice, these issues are addressed through care - ful trust drafting, use of ascertainable standards or independent trustees where appropriate, and ongoing careful administration. A number of jurisdictions in the United States have expressly adopted broad asset protection rules for trusts, albeit New York is not one of those jurisdic - tions. That being said, there are other asset protection vehicles, such as limited liability companies, which can be quite effective. 4.2 Succession Planning Several techniques can help family businesses transfer wealth to the next generation. One method involves utilising discounts for gift and estate tax planning, which typically requires the engagement 4. Family Business Planning 4.1 Asset Protection
tax as the owner of the trust. Where the donor gives property away to a trust but is still taxed on the trust income, the trust is commonly called a “grantor trust”. A beneficiary may also have certain powers that could cause a trust to be taxable in their estate. Under IRC § 2041, if a beneficiary possesses a “general power of appointment”, meaning that if the beneficiary can dis - tribute trust assets to themselves without an objective standard limiting their distribution power, those assets may be included in the beneficiary’s taxable estate. To avoid this result, trusts commonly limit distribution by using an ascertainable standard such as distributing all income annually, or limiting distributions to health, education, maintenance and support (HEMS). If broad distribution discretion is needed, then an independent trustee, someone who is not a beneficiary or closely related to the grantor or beneficiary (as defined in IRC § 672 (c)) should be appointed. For foundations, a donor is generally permitted to serve as a fiduciary, however, there are restrictions on self-dealing transactions, compensation and conflicts of interest. A foundation is an independent legal entity; therefore, the IRS imposes excise taxes to ensure the funds are used properly. Below are certain tax issues that foundations need to consider. • Self-dealing – under IRC § 4941, donors, substan - tial contributors and related parties (“Disqualified Persons”) are prohibited from engaging in financial transactions with the foundation. This includes sell - ing and leasing property to the foundation. Viola - tions carry an initial 10% penalty and can escalate up to 200% if they are not corrected. • Failure to distribute income – under IRC § 4942, foundations are legally required to distribute 5% of their net assets annually for charitable purposes. Failure to distribute at least 5% annually triggers a 30% excise tax on the undistributed amount. • Taxable expenditures – under IRC § 4945, founda - tions are not permitted to distribute funds for politi - cal campaigns, lobbying or directly to individuals without approved steps to track and supervise the use of funds. Violations trigger a 20% tax on the foundation.
807 CHAMBERS.COM
Powered by FlippingBook