Information Release

TRUST 2003-02 - Trust Residency — February 2003

The purpose of this information release is to explain, by way of examples, the definition of "trust residency" as set forth in division (I)(3) of Ohio Revised Code section (hereinafter, "R.C.") 5747.01.

Ohio law regarding state income tax on irrevocable trusts¹ classifies trust income into four categories:

• Qualifying trust amount,
• Qualifying investment income,
• Modified business income, and
• Modified nonbusiness income.

The vast majority of trusts will pay Ohio income tax only if they are resident trusts, and for most of those trusts, the tax will apply only to those trusts' modified nonbusiness income.² This information release focuses on the determination of trust residency.

Modified Nonbusiness Income. In general, modified nonbusiness income is the trust's income and gain that are earned and accumulated on investments not related to a business activity conducted by the trust (either by direct ownership of a business or by indirect ownership of a business via an equity investment in a pass-through entity).

Tests for Residency. There are nine independent tests applicable to determine if a trust is a resident trust. If any one of those nine tests for a taxable year applies to the trust, or part of the trust, then the trust, or that part of the trust, is a resident trust.³ This information release provides a summary of each of the nine tests. Following the summary for each test are notes and an example of the application of that test.⁴

Test #1 - Testamentary Trusts⁵

Two conjunctive requirements:

• On account of a decedent's death, property was transferred to a testamentary trust; and
• At the time of the testator's death, the testator of that testamentary trust was domiciled in Ohio for purposes of Ohio's estate tax.

Note to Test #1

There is no requirement that any beneficiary be domiciled in Ohio.

Example of Test #1

On account of a testator's death, real estate is transferred by will to the trustee of a testamentary trust created by the will of the testator who, at the time of death, was domiciled in Ohio for purposes of Ohio's estate tax.

The entire trust is a resident trust, even if no beneficiary is domiciled in Ohio.

Test #2 - Transferor Domiciled in Ohio at Time of Transfer to Irrevocable Trust⁶

Two conjunctive requirements:

• At the time property was transferred to an irrevocable trust, the transferor was domiciled in Ohio for purposes of Ohio's individual income tax; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.⁷

Notes to Test #2

The transferor of the property need not be the creator of the trust.

The transferor's domicile when the trust became irrevocable does not matter.

Example of Test #2

Individual A created a trust that became irrevocable while A was not domiciled in Ohio for purposes of Ohio's individual income tax. Thereafter, A moved to Ohio and, while domiciled in Ohio for purposes of Ohio's individual income tax, transferred property with a fair market value of $900 to the irrevocable inter vivos trust. Immediately prior to the transfer, the trust net assets had a fair market value of $100. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio for purposes of Ohio's individual income tax.

The trust is a resident trust for the current taxable year with respect to 90% of the trust's modified nonbusiness income (90% is the proportion of the trust attributable to the property A transferred to the trust while domiciled here).⁸

Test #3 - Transferor Domiciled in Ohio When Trust Became Irrevocable⁹

Two conjunctive requirements:

• When the trust document/instrument became irrevocable, the transferor of the property was domiciled in Ohio for purposes of Ohio's individual income tax; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Notes to Test #3

The transferor of the property need not be the creator of the trust.

The transferor's domicile when the property was transferred to the trust does not matter.

With regard to property previously transferred to an inter vivos trust that remained revocable until the transferor's death, the first requirement is met if, immediately preceding the transferor's death, the transferor was domiciled in Ohio for purposes of Ohio's individual income tax.

Example of Test #3

While domiciled outside Ohio for purposes of Ohio's individual income tax, individual A created a revocable inter vivos trust and immediately funded the trust with $1,000,000. Several years later, A moved to Ohio and remained domiciled in Ohio for purposes of Ohio's individual income tax until A's death, when the trust became irrevocable. During some portion of the trust's current taxable year at least one qualifying beneficiary is domiciled in Ohio. The entire trust is a resident trust for the current taxable year.

Test #4 - 3rd Party Transfer Became Irrevocable While Creator Domiciled in Ohio¹⁰

Four conjunctive requirements:

• Prior to the decedent's death, the decedent created an inter vivos trust while the decedent was domiciled in Ohio for purposes of Ohio's individual income tax;
• Prior to the decedent's death, the inter vivos trust became irrevocable while the decedent was domiciled in Ohio for purposes of Ohio's individual income tax;
• On account of the decedent's death, property was transferred to the irrevocable inter vivos trust; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Note to Test #4

The transferor of the property need not be the creator of the trust.

Example of Test #4

While domiciled in Ohio for purposes of Ohio's individual income tax, individual A created a revocable inter vivos trust and funded the trust with $10. Some time thereafter, the inter vivos trust became irrevocable while A remained domiciled in Ohio for purposes of Ohio's individual income tax. Subsequently, A permanently left Ohio for employment in another state. A's out-of-state employer purchased and owned a life insurance policy insuring A's life. The policy named as primary beneficiary the trustee of A's then-irrevocable inter vivos trust. After A's death, the insurance company remitted the life insurance proceeds to the trustee. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. The entire¹¹ trust is a resident trust for the current taxable year.

Test #5 - 3rd Party Transfer Became Irrevocable While Decedent Domiciled in Ohio¹²

Four conjunctive requirements:

• Prior to the decedent's death and while the decedent was domiciled in Ohio for purposes of Ohio's individual income tax (note: the trust need not be irrevocable at that time), the decedent transferred property to an inter vivos trust;
• Prior to the decedent's death, the inter vivos trust became irrevocable while the decedent was domiciled in Ohio for purposes of Ohio's individual income tax;
• On account of the decedent's death, property was transferred to the irrevocable inter vivos trust; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Note to Test #5

The transferor of the property need not be the creator of the trust.

Example of Test #5

While domiciled outside Ohio for purposes of Ohio's individual income tax, individual A created a revocable inter vivos trust and funded the trust with $10. Some time thereafter, A moved to Ohio and became domiciled in Ohio for purposes of Ohio's individual income tax. While A was domiciled in Ohio for purposes of Ohio's individual income tax and while A's parents were not, A's parents contributed $20,000 to the trust. For federal tax purposes, the contribution was treated as a gift to the creator and a transfer by the creator to the trust. Ohio follows this treatment. Shortly after that transfer, the trust became irrevocable while A remained domiciled in Ohio for purposes of Ohio's individual income tax. A subsequently moved outside Ohio and was no longer domiciled here. After that move, A's parents purchased and owned a $1,000,000 life insurance policy on A's life. The policy named as primary beneficiary the trustee of A's then-irrevocable inter vivos trust. A died and the insurance company remitted the life insurance proceeds to the trustee. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. The entire¹³ trust is a resident trust for the current taxable year.

Test #6 - 3rd Party Payment on Account of Pre-death Contract With Decedent¹⁴

Four conjunctive requirements:

• On account of a decedent's death, property was transferred to an irrevocable inter vivos trust;
• The transfer occurred as a result of a contractual relationship between the transferor and either the decedent or the estate of the decedent;
• At the time of the decedent's death, the decedent was domiciled in Ohio for purposes of Ohio's estate tax; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Note to Test #6

The transferor of the property need not be the creator of the trust.

Example of Test #6

Individual A, with no ties to Ohio, created a revocable inter vivos trust and funded the trust with $10. Subsequently, A moved to Ohio. At the time of A's death, the trust became irrevocable while A was domiciled in Ohio for purposes of Ohio's estate tax. Pursuant to A's retirement plan beneficiary designation, the out-of-state financial institution that was the custodian for A's Keogh plan remitted the entire fund amount to the trustee of the then-irrevocable inter vivos trust. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. The entire¹⁵ trust is a resident trust for the current taxable year.

Test #7 - 3rd Party Payment on Account of Pre-death Contract With Another Person¹⁶

Four conjunctive requirements:

• On account of a decedent's death, property was transferred to an irrevocable inter vivos trust;
• The property transfer occurs as a result of a contractual relationship between the transferor and another person;
• At the time of the decedent's death, that other person was domiciled in Ohio for purposes of Ohio's individual income tax;
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Note to Test #7

The transferor of the property need not be the creator of the trust.

Example of Test #7

Individual A, with no ties to Ohio, created a revocable inter vivos trust and funded the trust with $10. Subsequently, A's sibling, also with no ties to Ohio, purchased and owned a life insurance policy insuring A's life. The policy named as primary beneficiary the trustee of A's inter vivos trust. Later, A's sibling moved to Ohio and was domiciled in Ohio for purposes of Ohio's individual income tax at the time the trust became irrevocable upon A's death. The insurance company remitted the life insurance proceeds to the trustee of the then-irrevocable inter vivos trust. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. Nearly¹⁷ the entire trust is a resident trust for the current taxable year.

Test #8 - Pour-over Transfer¹⁸

Three conjunctive requirements:

• On account of a decedent's death, property was transferred to an irrevocable inter vivos trust;
• The transfer occurs on account of the will of the testator; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Notes to Test #8

The transferor of the property need not be the creator of the trust.

The statute does not require that the testator be domiciled in Ohio at any time.

Example of Test #8

While domiciled outside Ohio, individual A created a revocable inter vivos trust and funded the trust with $10. A subsequently moved to Ohio and, at the time of A's death, the inter vivos trust became irrevocable while A was domiciled in Ohio for purposes of Ohio's estate tax. A's will contained a "pour over" provision directing the representative of A's estate to transfer $300,000 cash to the trustee of the then-irrevocable trust. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. The entire¹⁹ trust is a resident trust for the current taxable year.

Test #9 - Court-created Trust²⁰

Four conjunctive requirements:

• On account of a decedent's death, property was transferred to an irrevocable inter vivos trust;
• The trust was created by, or caused to be created by, a court as a result of the death of an individual;
• At the time of the individual's death, the individual was domiciled in Ohio for purposes of Ohio's estate tax; and
• For all or some portion of the trust's current taxable year, at least one of the trust's qualifying beneficiaries (defined below) is domiciled in Ohio for purposes of Ohio's individual income tax.

Note to Test #9

The court need not be an Ohio court.

Example of Test #9

Individual A died as a result of a two-car automobile accident in Michigan. At the time of A's death, A was domiciled in Ohio for purposes of Ohio's estate tax. A's minor children commenced litigation in Michigan against the driver of the other automobile. The Michigan court awarded damages of $1,000,000 and, because the plaintiffs were minors, created a trust for the benefit of the children. During some portion of the trust's current taxable year, at least one qualifying beneficiary is domiciled in Ohio. The entire trust is a resident trust for the current taxable year.

Qualifying Beneficiary.²¹ For trusts other than charitable lead trusts, a qualifying beneficiary is any potential current beneficiary²² other than a beneficiary to which a contribution would qualify for the IRC 170 charitable contribution deduction. For charitable lead trusts, a qualifying beneficiary is any current, future, or contingent beneficiary other than a beneficiary to which a contribution would qualify for the IRC 170 charitable contribution deduction.

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If you have questions regarding any matter discussed in this release, please call 1-800-282-1780 (Ohio Relay Service for the Speech or Hearing-Impaired: 1-800-750-0750), or e-mail us through our web site at http://tax.ohio.gov/.

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¹R.C. 5747.01(I)(3)(b) states: "A trust is irrevocable to the extent that the transferor is not considered to be the owner of the net assets of the trust under sections 671 to 678 of the Internal Revenue Code."

²Generally, only resident trusts will pay Ohio income tax on undistributed modified nonbusiness income. However, R.C. 5747.01(BB)(4)(c)(ii) requires nonresident trusts to pay Ohio income tax on certain modified nonbusiness income having an Ohio situs. Examples of such income include, but are not limited to, Ohio Lottery Commission winnings and gains from sales of Ohio real estate.³Note that the location of the trustee and the location of the administration of the trust’s assets are irrelevant with respect to the statutory residency requirements. See R.C. 5747.01(I)(3).⁴The titles used for each test are solely for illustrative purposes.⁵R.C. 5747.01(I)(3)(a)(i) and 5747.01(I)(3)(e)(i).

⁶R.C. 5747.01(I)(3)(a)(ii).

⁷See R.C. 5747.01(I)(1) and 5747.24.⁸See R.C. 5747.01(I)(3)(d).

⁹R.C. 5747.01(I)(3)(a)(iii).

¹⁰R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(i).

¹¹Under Test #3, the fair market value of net assets resulting from the $10 transfer is a resident part of the trust.

¹²R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(ii).

¹³Under Test #3, the fair market value of net assets resulting from the $20,010 in transfers is a resident part of the trust.

¹⁴R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(iii).¹⁵Under Test #3, the fair market value of net assets resulting from the $10 transfer is a resident part of the trust.

¹⁶R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(iv).

¹⁷The fair market value of net assets resulting from the $10 transfer is not a resident part of the trust.¹⁸R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(v).

¹⁹Under Test #3, the fair market value of net assets resulting from the $10 transfer is a resident part of the trust.

²⁰R.C. 5747.01(I)(3)(a)(i), 5747.01(I)(3)(e)(ii), and 5747.01(I)(3)(f)(vi).

²¹R.C. 5747.01(I)(3)(c).

²²See IRC 1361(e)(2).