USA – CALIFORNIA Law and Practice Contributed by: Jennifer J. McCall, Matthew Perotti and Ashley E. Huh, Pillsbury Winthrop Shaw Pittman LLP
10. Fiduciary Regulation, Standards and Taxation 10.1 Corporate and Professional Fiduciaries Corporate fiduciaries – such as banks and trust com- panies – are frequently appointed to serve as trus- tees or executors. These institutions must generally be authorised to conduct fiduciary business and are typically chartered, authorised, and regulated as a bank, trust bank, or trust company under applicable banking laws. While all trustees have fiduciary duties, including but not limited to prudent administration and loyalty, a corporate fiduciary is usually held to a higher standard because of its specialised skills and expertise. Corpo- rate fiduciaries must also adhere to the prudent inves- tor rule, unless this requirement is waived under the terms of the trust agreement. In addition, many states permit the formation of pri- vate trust companies. The regulatory requirements for these entities vary by state and may include standards for capitalisation, governance and reporting. 10.2 Taxation of Trusts Both state and federal tax laws apply to trusts and similar structures. Generally, property rights are deter- mined under state law, while the taxation of various interests in property is governed by both federal law and the relevant state laws that may have a connec- tion to the trust. Because each state has its own rules for determining how a trust, its settlor, or its beneficiar- ies are taxed, a careful review of applicable state law is essential before creating or administering a trust within the United States. In general, a trust – other than a grantor trust dis- cussed below – must file both state and federal income tax returns for any income it earns. If a dis- tribution is made to a beneficiary during the trust’s tax year (generally the calendar year), that distribution will “carry out” distributable net income (DNI) to the beneficiary. The amount of DNI carried out is reported to the beneficiary on a Schedule K‑1, which is pre- pared as part of the trust’s federal income tax return (Form 1041) and then sent to the beneficiary. The trust receives a corresponding distribution deduction for
such income, resulting in the beneficiary – not the trust – being taxed on that portion of DNI. Ordinary income is included in DNI, but capital gains generally are not. As a result, capital gains are typically taxed at the trust level. This may create a mismatch when claiming foreign tax credits in jurisdictions that tax the capital gain directly to the beneficiary – for example, under UK rules – because the US taxes the gain to the trust, not to the beneficiary. A trust that qualifies as a grantor trust, however, is treated differently: all of its income is taxed directly to the grantor. In this case, the trust is generally not required to file its own tax return; instead, its income is reported on the grantor’s personal return. Various rules determine when a trust is treated as a grantor trust. Examples include: a trust that may use its income to pay premiums on insurance on the grantor’s life; a trust that allows the grantor, acting in a non‑fiduciary capacity, to substitute property of equivalent value for trust assets; a trust that the grantor has the power to revoke; or a trust where the grantor (or a person considered “related” or “subordinate”) has the power to determine the enjoyment of the trust’s income or principal. From a planning perspective, a grantor trust regime may be advantageous because the grantor is respon- sible for paying the income tax attributable to the trust’s assets. Since this effectively allows the trust to grow without bearing its own tax liability, it enhances the value of the trust. Importantly, this tax payment is not considered a taxable gift under US law, because it is the grantor’s own tax obligation. Certain states do not impose a state income tax. These currently include:
• Alaska; • Florida; • Nevada; • New Hampshire; • South Dakota; • Tennessee; • Texas; • Washington; and • Wyoming.
220 CHAMBERS.COM
Powered by FlippingBook