Was an out-of-state trust a Virginia resident trust after its family moved to Virginia, and could LLC income still create Virginia tax?

Subject

A nonresident trust is liable for income tax on its share of income, gain loss and deduction attributable to Virginia sources.

Plain-English summary

Virginia found that the trust was not a resident trust after December 26, 2013, but it could still owe Virginia tax on source income. The trust had been created outside Virginia by a nonresident grantor, held no Virginia property directly, and was not supervised by a Virginia court. The original trustee became a Virginia resident but resigned on the family's move date, and the successor trustees were nonresidents, so the trust was not administered in Virginia after that date.

The harder question was whether the trust had validly changed from a grantor trust to a complex trust when the grantor relinquished a power on December 31, 2013. Virginia could not identify the governing state's law or decide whether that modification was legally effective.

Either way, source income mattered. The trust owned an LLC with a Virginia office, so some pass-through income might be attributable to Virginia business. If the trust remained a grantor trust, the grantor could have a nonresident individual filing obligation. If it validly became a complex trust, the nonresident trust could owe fiduciary income tax on its Virginia-source share.

What this means for you

• Trust residence and Virginia-source income are separate questions.
• Track where the grantor lived at creation, where assets and trustees are located, and whether a Virginia court supervises administration.
• Confirm a trust modification under the law that actually governs the instrument.
• Analyze pass-through entity operations to determine whether the grantor or trust receives Virginia-source income.

Common questions

Q: Did the family's move to Virginia make the trust resident?

A: No, because the Virginia-resident trustee resigned that day and the trust was thereafter administered by nonresident trustees.

Q: Did Virginia decide that the grantor-to-complex conversion was valid?

A: No. The governing state law and legal effectiveness were unresolved.

Q: Could a nonresident trust still owe Virginia tax?

A: Yes, on its share of income, gain, loss, and deduction attributable to Virginia sources.

Citations and references

• Va. Code §§ 58.1-302, 58.1-325, 58.1-362, 58.1-381, 58.1-392, and 64.2-729.
• 23 VAC 10-115-10.
• IRC §§ 651, 661, and 671.
• P.D. 06-44, P.D. 07-50, and P.D. 97-343.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-46

Original ruling text

March 18, 2015

Re: Ruling Request: Fiduciary Income Tax

Dear *:

This will respond to your letter in which you request a ruling as to whether a trust is a Virginia resident trust. I apologize for the delay in responding to your request.

FACTS

An irrevocable trust (the "Trust") was created by a grantor (the "Grantor") under * (State A) law in December 2005. The Trust is treated as a grantor's trust forfederal income tax purposes. The Grantor's spouse was named sole trustee (Trustee A) of the Trust. The Trust's sole beneficiaries were the Grantor and Trustee A's minor children. At the time of the Trust's creation, both the Grantor and Trustee A were residents of *** (State B). The only property held by the Trust is ownership units of a limited liability company (the "LLC"). The LLC is headquartered in another state, but maintains an office in Virginia.

On December 26, 2013, the Grantor, Trustee A and the beneficiaries moved to Virginia. On that date, Trustee A resigned as trustee and an * (State C) resident was named trustee (Trustee B). On December 31, 2013, the Grantor relinquished his power to substitute assets of equivalent value in order to convert the trust from a grantor trust to a complex trust. In February 2014, Trustee B resigned and the Trust Company (Trustee C), which operates in ** (State D), was appointed.

Trustee C seeks a ruling that the Trust is not a Virginia resident trust and is not required to file a Virginia resident fiduciary income tax return for taxable years beginning on and after December 26, 2013

RULING

Residency

Virginia Code § 58.1-381 provides that all resident trusts which are required to file a federal income tax return or that have any Virginia taxable income must file an income tax return in Virginia. A "resident trust" is defined in Va. Code § 58.1-302 includes:

An estate of a decedent who was domiciled in Virginia at the time of their death;

A trust created by will of a decedent who was domiciled in Virginia at the time of their death;

A trust created by or consisting of property of a person domiciled in Virginia; or

A trust or estate that is administered in Virginia.

The Grantor was living at the time the Trust was created. Therefore, the Trust does not fit within the first two definitions of a resident trust. The Grantor was not a resident of Virginia when the Trust was created, and the Trust owns no property in Virginia. Thus, the third definition is not applicable. Accordingly, the relevant issue would be whether the Trust is being administered in Virginia. Title 23 of the Virginia Administrative Code (VAC) 10-115-10 provides that a trust is being administered in the Commonwealth if its "assets are located in Virginia, its fiduciary is a resident of Virginia, or it is under the supervision of a Virginia court." Under this general rule, a trust would be considered to be administered in Virginia if its trustee is a resident of Virginia.

In this case, Trustee A, who was a Virginia resident, surrendered the Trustee position to Trustee B, a non resident trustee on December 26, 2013. As such, the Trust ceased being administered in Virginia after that date. Therefore, the Trust would not be considered a resident trust for fiduciary income tax purposes and would not be required to file Virginia fiduciary income tax returns.

Grantor and Complex Trusts

A simple trust is any trust that requires that all income be distributed to its beneficiaries, no other amounts are distributed and no amounts are paid or set aside for charities. See Internal Revenue Code (IRC) § 651. Under § 661, a complex trust is any trust that is not a simple trust. As such, distributions can be made out of the principal and to charities. Both simple and complex trusts are subject to fiduciary income tax. The Trust, as originally created, is an irrevocable grantor trust.

Under the grantor trust rules, a grantor who transfers property to a trust and retains certain power or interests is treated as the owner of the trust for income tax purposes. As a result, the income and deductions attributable to the trust are reported by the grantor on his individual income tax return. See IRC § 671 and Public Document (P.D.) 06-44 (4/11/2006).

In this case, the Trustee C asserts that the Trust was converted from an irrevocable grantor trust into a complex trust as of December 31, 2013 by relinquishing certain powers. It argues that there would be no Virginia fiduciary income tax liability because the Trust would be a nonresident trust without income from Virginia sources.

Under Va. Code § 64.2-729 of the Uniform Trust Code, a non-charitable irrevocable trust can only be modified through a court order. Absent a court order approving a modification, it appears the Trust would remain a grantor's trust under Virginia law and would pass income subject to tax through to the Grantor.

The Trust, however, was made in accordance with State A law when the Grantor was a resident of State B and is currently being administered in State D. As such, the Department is unable to determine which state's law is applicable and whether the Trust was legally modified in accordance with the appropriate state law. If the Trust was legally modified into a complex trust, it would be subject to Virginia fiduciary income tax on any Virginia source income.

Virginia Source Income

Virginia Code § 58.1-362 provides that the Virginia taxable income of a nonresident trust is its share of income, gain, loss and deduction attributable to Virginia sources with certain adjustments.

According to the information provided, the Trust may receive income from the LLC that is generated in part from business conducted in Virginia. The LLC is a pass through entity for income tax purposes. Under Va. Code § 58.1-392, pass-through entities (including S corporations, partnerships, and limited liability companies) doing business in Virginia or having income from Virginia sources are required to file a return with the Department. See P.D. 07-50 (4/26/2007). Pursuant to Va. Code § 58.1-302, an entity has income from Virginia sources if it has any items of income, gain loss and deduction attributable to ownership in real or tangible personal property in Virginia or resulting from a business, trade, profession, or occupation carried on in Virginia.

As such, if a portion of the income from the LLC is Virginia source income, the Grantor or the Trust may be liable for Virginia income tax. See P.D. 97-343 (8/28/1997). Because the LLC has an office in Virginia, it may have income from Virginia sources.

The Trust was treated as a Grantor's trust for federal income tax purposes at its creation in 2005. Because the LLC may have had income from Virginia sources, the Trust may have had Virginia source income prior to the Grantor, Trustee A and the beneficiaries moving to Virginia in 2013. Under Va. Code § 58.1-362, a nonresident trust is liable for income tax on its share of income, gain loss and deduction attributable to Virginia sources. If the Trust income was passed through to the Grantor, he may be required to file nonresident individual income tax returns pursuant to Va. Code § 58.1-325.

This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections, regulation, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5664781066.B