Pennsylvania Senate Bill 815, signed into law on December 14, 2023, amended the Pennsylvania tax code to recognize irrevocable grantor trusts for tax years beginning after January 1, 2025.
Prior to the passing of this bill, Pennsylvania was the only state that did not align with federal grantor trust rules, allowing the grantor of the trust to be treated as the owner of all or part of the trust for income tax purposes. One issue that arose from Pennsylvania’s treatment of irrevocable grantor trusts as a separate taxable entity from the grantor was the inability of trusts and/or grantors who were taxed on the same income in multiple states to claim a credit for taxes paid to other states.
A common planning technique used with grantor trusts is sales and exchanges between the grantor and the grantor trust. Historically, these transactions were ignored for federal and other state income tax purposes since the grantor trust is not a separate taxable entity but would have been taxable transactions for Pennsylvania. These transactions will now be disregarded for Pennsylvania income tax purposes as well. As an example, a grantor trust may purchase a business entity from the grantor in exchange for an interest-bearing promissory note equal to the fair market value of the business interest; this transaction would not result in recognition of gain on the sale or interest income on the note since the buyer and seller are the same taxable entity.
From an estate planning perspective, the ability of the grantor to pay Pennsylvania income taxes from personal funds rather than trust funds allows the assets in the trust to grow income tax-free outside of the grantor’s estate while also reducing the grantor’s taxable estate. The grantor’s payment of income taxes on trust income is effectively a tax-free gift to the trust.
Although the Department of Revenue has not issued guidance yet on income tax return filing requirements or other items related to the change in tax law, we expect that guidance is forthcoming.
This change may bring new tax planning opportunities, and your Withum tax advisor is available to explain how these changes impact you.
Author: Erin McDonald, CPA | [email protected]
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