Pennsylvania adopts federal grantor trust rules: PwC

Pennsylvania adopts federal grantor trust rules

December 2023

In brief

What happened?

Pennsylvania Governor Josh Shapiro (D) on December 14 signed a tax bill that incorporates federal grantor trust rules into Pennsylvania’s income tax law, which now requires any person treated as an owner of an irrevocable grantor-type trust to pay state personal income tax on the trust’s income regardless of their receipt of such income.

Why is it relevant?

The new law requires any individual who is treated as the owner of a trust under Internal Revenue Code Sections 671 to 679 to report all classes of income on their Pennsylvania personal income tax return even if they do not receive an income distribution from the trust. This represents a dramatic shift in the Pennsylvania income tax reporting requirements of irrevocable grantor trusts in Pennsylvania in that the income will no longer be taxed to the trust nor its beneficiaries. These new reporting and filing requirements become effective for tax years beginning in 2025 for grantors or other individuals treated as the owner of an irrevocable grantor-type trust in Pennsylvania.

Actions to consider:

Grantors and other individuals need to consider additional income from the trust that could impact their quarterly estimated tax payments for Pennsylvania state income tax purposes. Grantors and other individuals who are residents of municipalities that tax unearned income will need to confirm whether such income needs to be reported to their local municipality.

The new law also may change reporting and filing requirements for trustees. For a grantor-type trust, the trustees will no longer need to make state quarterly estimated tax payments on behalf of the trust, pay tax on the income received by the trust, or issue tax letters to the beneficiaries. Also, beneficiaries who previously were taxed on income distributed to them should consider changes to their tax filing requirements.

In detail

The new law provides that income received by a trust is taxable to either the grantor of the trust or any other individual who is treated as the trust owner under Sections 671 to 679. This new tax treatment applies regardless of whether the income is accumulated within the trust and not distributed to the beneficiaries or if the income is distributed to the beneficiaries. The law shifts the responsibility of reporting and paying the tax away from a grantor-type trust and its beneficiaries and places it firmly on the grantor or other individual who is treated as the owner of such trust under the federal grantor trust rules.

Prior to this change in law, Pennsylvania was the only state that failed to recognize an irrevocable grantor-type trust even though it recognized revocable grantor trusts. This disconnect between federal and state tax law created two different tax reporting requirements at the federal and state level. At the federal level, the grantor or other individual who was treated as the owner of the trust reported all income associated with the trust regardless if the income was distributed to them. But, at the state level, the trust was taxed on undistributed income and the beneficiaries were taxed on income distributed to them. This disconnect created an administrative burden and hindered estate planning attempts.

The new law goes into effect on February 12, 2024, 60-days from the date it was enacted on December 14, 2023. Extending the effective date out 60 days pushes the change in reporting and filing requirements to tax years beginning on or after January 1, 2025.