Review Your Non-Grantor Trust to Save on State Income Taxes
If you've been procrastinating on reviewing that old trust, now is the time to take a second look.


Smart state income tax planning for trusts, in particular, can offer some surprising benefits. That’s why it’s important to regularly review your documents in order to maximize savings. Many trusts operate on autopilot for years if not decades. Financial advisers with experience in trust taxation can help implement the best tax-savings strategies for your trusts.
Consider the case of Gloria:
Gloria created a trust for the benefit of her two sons, Jason and Max, with her cousin Shelly as trustee. The trust was irrevocable, which means it generally cannot be amended or revoked. At the time of the trust’s creation, everyone lived in the Bronx. The trust was initially created as a “grantor” trust, meaning that Gloria was personally responsible for paying the tax generated by the trust’s income. Even when a trust is irrevocable, its tax status can sometimes be changed from grantor to non-grantor (or vice versa). So, when Gloria retired and became sick of paying the trust’s tax bill, she decided to “turn off” grantor trust status, thereby making it a “non-grantor” trust. She also decided to move to Florida. To be close to his aging mother, Jason soon followed. But Max and Shelly, both die-hard Yankees fans, stayed in the Bronx.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The key feature of Gloria’s trust is that it is irrevocable. This is different from a “revocable” or “living” trust, which can be revoked at any time for any reason. With revocable trusts, the grantor is always the taxpayer. An irrevocable trust, on the other hand, can be treated as either a grantor trust or a non-grantor trust for income tax purposes.
When her trust was a grantor trust, Gloria was responsible for paying all taxes owed on the trust income. Once Gloria’s trust became a non-grantor trust, however, the responsibility for paying tax on the income generated shifted to the trust (and Shelly, as the trustee) — unless there was a distribution to Max or Jason. If Max or Jason received a distribution from the trust, either would generally be responsible for all or a portion of the tax due.
States differ in their rules on taxation of non-grantor trusts. Many states, including New York and New Jersey, impose income tax on a non-grantor trust created by a person while a resident of that state, whether created during the grantor’s life or under her will. Other states impose income tax on trusts that are administered in the state, or have trustees or beneficiaries in the state.
Yet, some states offer exceptions to their rules of taxation. In New York and New Jersey, for example, there is a three-pronged exception from the imposition of state income tax if:
- The trustee resides outside of the state,
- There are no trust assets located in the state, and
- There is no source income from the state.
In many states, periodically asking these two simple questions can assist the trustee of a non-grantor trust in determining the state income tax consequences of an action:
- Where do the trustees live?
- Where do the beneficiaries live?
Let’s examine how these factors impact the taxation of Gloria’s trust.
After Gloria retired and moved to Florida, the trust would have to continue to pay New York income taxes, because Gloria created it when she was an Empire State resident and the trust continues to have New York ties, via Shelly, the trustee. What can be done?
Since New York carves out the three-pronged exception described above, it may be wise to replace Shelly with a non-New York trustee. It will be important, however, to ensure that Shelly’s replacement doesn’t live in a state that taxes non-grantor trusts based on the residency of the trustee as this could result in trading New York taxation for taxation in another state.
If distributions are made to Max or Jason, knowing the tax impact on each is key. Assume Shelly has been replaced and the trust no longer pays New York income tax. Jason asks for a trust distribution and the trustee agrees. Max doesn’t need distributions now, but because he worries Jason’s distributions will deplete the trust, he begins receiving distributions as well. Jason will not pay state income tax on his distribution because Florida has no income tax. Max’s distributions, however, will be subject to New York income tax.
One way to address this situation is to structure the distribution to Max and/or Jason as a loan, which could be more tax-efficient, particularly for Max. If the trust agreement permits, another alternative is to segregate the trust into two sub-trusts: one for Jason and one for Max.
In doing so, Jason’s distributions would only deplete his share. As an added advantage, each share would have a separate investment allocation. This can be valuable if the beneficiaries receiving distributions live in different states. For example, it may make sense for Max’s share to have a municipal bond allocation with a New York bias, whereas this would not be appropriate for Jason.
Many state income tax planning opportunities exist when administering an irrevocable non-grantor trust. Your financial adviser can help you understand and implement these strategies and ensure your trust is set up in the most tax-efficient way, especially if there has been a change of residence for any party in the trust.
Eric Dostal contributed to this article.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

In her role as Director of Trusts and Estates at Sontag Advisory, Nicole's primary focus is to provide trust and estate advice to the advisers and clients of the firm.
-
Key to Financial Peace of Mind: Think 'What's Next?' Rather Than 'What If?'
Even if you've hit your magic number for retirement, it's hard to stop worrying about money. Giving it a clear purpose is one way to reduce financial anxiety.
-
Three Estate Planning Documents a Business Owner Can't Afford to Skip
A business owner's estate plan should protect the company and its employees as well as the entrepreneur's heirs. These three documents are critical.
-
Key to Financial Peace of Mind: Think 'What's Next?' Rather Than 'What If?'
Even if you've hit your magic number for retirement, it's hard to stop worrying about money. Giving it a clear purpose is one way to reduce financial anxiety.
-
Three Estate Planning Documents a Business Owner Can't Afford to Skip
A business owner's estate plan should protect the company and its employees as well as the entrepreneur's heirs. These three documents are critical.
-
Financial Fact vs Fiction: Why Your 'Magic Number' Isn't Actually Magical
Do you think you're diversified if you're invested in the S&P 500 and Nasdaq? Do you think your tax rate will fall in retirement? Think again — and read on for other myths that could be leading you astray.
-
Opportunity Zones: An Expert Guide to the Changes in the One Big Beautiful Bill
The law makes opportunity zones permanent, creates enhanced tax benefits for rural investments and opens up new strategies for investors to combine community development with significant tax advantages.
-
Five Ways Retirees Can Keep Perspective Through Market Jitters
Market volatility is a recurring event with historical precedents (the dot-com bubble, global financial crisis and pandemic), each followed by recovery. Here's how people who are near or in retirement can navigate economic uncertainty.
-
I'm a Financial Strategist: This Is the Investment Trap That Keeps Smart Investors on the Sidelines
Forget FOMO. FOGI — Fear of Getting In — is the feeling you need to learn how to manage so you don't miss out on future investment gains.
-
Can You Be a Good Parent to an Only Child When You're Also a Business Owner?
Author and social psychologist Susan Newman offers advice to business-owner parents on how to raise a well-adjusted single child by avoiding overcompensation and encouraging chores.
-
How Advisers Can Steer Their Clients Through Market Volatility (and Strengthen Their Relationships)
Financial advisers need to be strategic when they communicate with clients during market volatility. The goal is to not only reassure them but to also help them avoid rash decisions, deepen your relationship with them and build lasting trust.