Pennsylvania conforms to federal income taxation of irrevocable grantor trusts

Recently Pennsylvania Governor Josh Shapiro signed legislation updating Pennsylvania law to conform with the federal income tax treatment of grantor trusts.

This change, which will be implemented for tax years beginning on, or after, January 1, 2025, requires that any person treated as the owner of an irrevocable grantor trust must pay the personal income taxes on the trust’s income. 

Prior to this change in law, Pennsylvania was the only state that had different taxing regimes for revocable and irrevocable grantor trusts.

For Pennsylvania purposes, the income generated by a revocable grantor trust is included on the grantor/settlor’s personal income tax return (PA Form 40), and the grantor/settlor is responsible for paying any Pennsylvania income tax liability. This treatment is identical to how revocable grantor trusts are treated for federal income tax purposes. However, prior to this recent change, Pennsylvania taxed the undistributed income of an irrevocable grantor trust at the trust level. This is different treatment than that for federal income tax purposes where the income realized by irrevocable grantor trusts is taxed at the grantor/settlor level.

Under the new law, the income generated by an irrevocable grantor trust will be reported in the same manner as the income from a revocable grantor trust. The grantor will include the various classes of income on their personal income tax return, and they, not the trustee, will be responsible for making any state income tax payments. This change accomplishes two objectives; first it creates consistency in reporting grantor trusts between Pennsylvania and various other states. Second, it allows the grantor to further reduce his gross estate by the amount of Pennsylvania income taxes owed on that income.

Tax consequences to grantor/trustee under rules through 12/31/24

Taxpayer, a resident of Pennsylvania creates a trust for the benefit of his child. The trust generated interest income of $100,000 and capital gains of $400,000. If this trust was treated as a revocable grantor trust, the grantor would be responsible for reporting the $500,000 of taxable income on his personal income tax return as well as paying the $15,350 in Pennsylvania income taxes.

Alternatively, if this trust was treated as an irrevocable grantor trust and the trust did not distribute any assets to the beneficiary, the trustee would be responsible for reporting the $500,000 of taxable income on the trust’s fiduciary income tax return as well as paying the $15,350 in state taxes from the assets inside the trust (assuming the trustee made no distributions to the trust’s beneficiaries). 

Tax consequences to grantor/trustee under rules beginning on or after 1/1/2025

Assume the same facts as in the above example. If the income is earned in 2025, there is no difference in the Pennsylvania income tax treatment regardless of whether the trust is a revocable or irrevocable grantor trust. Furthermore, the taxpayer would now use his own funds to pay the Pennsylvania income tax related to the income generated by the irrevocable grantor trust, thus, reducing his taxable estate.

Mazars’ insight

This change eliminates some of the complexities associated with administering irrevocable grantor trusts in Pennsylvania and filing the required state tax returns. As a result of the change, taxpayers may need to reconsider their required quarterly estimated tax payments due to added income from the irrevocable grantor trust. Finally, taxpayers may need to reevaluate the benefit of grantor trust status if the additional tax burden significantly impacts their cash flow and lifestyle.

Please contact your Mazars professional for additional information.

Author

Mark Puliti, Manager 

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.