New state law changes I&D rules for some trusts
Under the measure, proceeds from non-grantor trusts are not taxable
For quite a few years now, New Hampshire has been making strides to make this the most attractive state in which to create and administer trusts through the passage of sweeping, trust-favorable legislation, which included the Uniform Trust Code and the Trust Modernization Act.
These laws have given New Hampshire residents and nonresidents alike a strong incentive to create and administer their trusts in New Hampshire. To further this objective, New Hampshire has passed yet another piece of legislation to enhance the favorability of trust administration in New Hampshire – Senate Bill 326.
The relevant sections of SB 326 amend the interest and dividends tax. The tax that was historically imposed on non-grantor trusts is now eliminated. Unlike a "grantor trust," the income of which is reported by the trust's creator for federal income tax purposes, a non-grantor trust is taxed as a separate entity for federal income tax purposes.
Non-grantor trusts are used for a wide variety of estate tax-planning purposes, including the use of the $5.25 million gift tax exemption.
With the passage of this new legislation, interest and dividends earned by non-grantor trusts will not be subject to the interest and dividends tax in the year the interest and dividends are earned at the trust level.
Instead, in any year that there is a distribution to one or more trust beneficiaries, then any trust beneficiary who is a resident of New Hampshire may be subject to the I&D tax on a portion of the distribution that constituted interest and dividends earned in that year by the trust.
If a non-grantor trust accumulates interest and dividends over a period of years, those interests and dividends will not be subject to the I&D tax. In a future year when the accumulated interest and dividends are distributed to the trust beneficiaries, the beneficiaries who are New Hampshire residents will be subject to I&D tax only on their pro rata share of the interest and dividends earned in the year of distribution.
In other words, the interest and dividends earned by the trust in prior years when no distributions were made will never be subject to the I&D tax. Moreover, if the beneficiaries of the trust are out-of-state residents, they will not be subject to the I&D tax at all, meaning the interest and dividends earned by the trust will completely escape the tax.
S corporations and LLCs
There is another, and possibly more important feature of the new law. Distributions from S corporations and certain limited liability companies and partnerships are taxed as dividends for purposes of the I&D tax.
Currently, if an interest in any S corporation, or a partnership or limited liability company with transferable shares, is transferred into a New Hampshire non-grantor trust, then distributions from those business entities to the trust will not be subject to the I&D tax because non-grantor trusts are no longer subject to it.
Subsequent distributions from the trust to the trust's beneficiaries will then only be subject to the I&D tax at the beneficiary level, to the extent that the distribution carries out income that is federally taxed as interest or dividends. Since distributions from S corporations, LLCs and partnerships are generally not taxed federally as dividends, distributions from the trust to its beneficiaries should not be subject to the I&D tax either.
Note that the interest and dividends taxation of grantor trusts has not been changed. In the case of a grantor trust, if the grantor is a New Hampshire resident, then the interest and dividends earned by the grantor trust will be taxable on the grantor's personal I&D tax return.
While there are a number of different types of grantor trusts, the most common is the traditional estate planning revocable trust.
The trust planning opportunities available under the new law will be applicable for all tax periods ending on or after Dec. 31, 2013. For trusts that file on a calendar year basis, this legislation will apply to interests and dividends earned, and distributions made, to a New Hampshire non-grantor trust any time after Jan. 1, 2013.
Attorney Anu Mullikin, chair of the Trust and Estates Practice Group at the law firm of Devine Millimet, is a fellow of the American College of Trust and Estate Counsel and a past president of the New Hampshire Estate Planning Council. She can be reached at 603-695-8536 or firstname.lastname@example.org.