Grantors of Pennsylvania irrevocable trusts may now elect to pay the income taxes on the trusts’ income under the recently signed Act 64 of 2023, provided that such trusts qualify as “grantor trusts” under federal tax law. For decades, Pennsylvania has deviated from federal income tax laws by specifically prohibiting grantor trust tax status for irrevocable trusts. This new act simplifies the rules for irrevocable trusts to mirror those in other jurisdictions, and it provides an opportunity for grantors to plan for new irrevocable trusts, and for grantors, trustees, and beneficiaries to review certain existing irrevocable trusts.

Historical and New Treatment for State Income Taxation of Pennsylvania Irrevocable Trusts

Since 1971, Pennsylvania and federal laws have differed in their tax treatment for irrevocable trusts, even when the grantor retained certain powers under the trust instrument. Under federal law, a grantor of an irrevocable trust (or another person) can be taxed on the trust income to the extent that the grantor (or such other person) is deemed the “owner” of such trust under the Internal Revenue Code (the code) Sections 671 through 679 (the “grantor trust powers”), regardless of whether such income is distributed to the beneficiaries or accumulated. Under prior Pennsylvania law, however, a Pennsylvania resident trust (or nonresident trust, to the extent of its sources within the commonwealth) was subject to tax on its income received during the trust’s taxable year at a rate of 3.07%, regardless of whether the grantor (or another person) held such grantor trust powers.