California Withholding on Trust Distributions Explained
Navigate the tax compliance duties for trustees making distributions of California-source income to nonresidents. A guide to the state's tax prepayment system.
California withholding on trust distributions is a prepayment of a beneficiary’s state income tax liability, not a separate tax. This system ensures the state collects taxes on income generated within its borders that is paid to nonresidents. The trustee is responsible for withholding a portion of certain distributions and remitting it to the California Franchise Tax Board (FTB). This process is similar to how an employer withholds taxes from a paycheck, and failure to comply can lead to penalties and interest for the trustee.
Determining When Withholding is Required
A trustee must withhold taxes on a trust distribution if two conditions are met. The first is that the distribution is made to a nonresident beneficiary. A nonresident can be an individual living outside California, a corporation not qualified to do business in the state, or a trust without a resident trustee, grantor, or beneficiary.
The second condition is that the distribution includes California-source income. This is income from assets or activities in California, such as rent from California real estate or capital gains from selling property in the state. Income from intangible assets like stocks and bonds is not considered California-source income unless it has a business purpose within the state.
A monetary threshold also applies. Withholding is only required if the total distributions of California-source income to a single nonresident beneficiary exceed $1,500 in a calendar year. No withholding is necessary if the total is $1,500 or less.
Calculating the Withholding Amount
The standard withholding rate is 7% of the California-source income being distributed. This rate applies only to the portion of the distribution classified as distributable net income (DNI) from California sources, not the entire distribution amount.
For example, a trust earns $30,000 in total income, with $10,000 from California rental property and $20,000 from stock dividends. If the trustee distributes the $10,000 of rental income to a nonresident beneficiary, the withholding is calculated only on that amount.
The trustee must withhold 7% of $10,000, which is $700. The beneficiary receives $9,300, and the trustee remits the $700 to the FTB.
Required Forms and Documentation
Proper documentation is a central part of the withholding process. The primary forms involved include:
- Form 590, Withholding Exemption Certificate: A beneficiary completes this form to certify they are a California resident, which exempts distributions from withholding.
- Form 587, Nonresident Withholding Allocation Worksheet: The trustee uses this form to detail the different income types and allocate how much is from California sources. This worksheet supports the withholding calculation and is kept for the trustee’s records.
- Form 588, Nonresident Withholding Waiver Request: A nonresident beneficiary files this form with the FTB to request a waiver from withholding. A waiver may be granted if the beneficiary has a history of filing California tax returns or if the 7% withholding would result in a significant overpayment.
- Form 592-B, Resident and Nonresident Withholding Tax Statement: After withholding funds, the trustee uses this form to report the amount to the beneficiary. It shows the income subject to withholding and the tax withheld on their behalf.
All forms require identifiers like the trust’s name and Federal Employer Identification Number (FEIN) and the beneficiary’s name and Social Security Number or Taxpayer Identification Number (TIN).
The Withholding and Reporting Process
Withheld funds are remitted to the FTB on a quarterly basis. Payments are due by April 15, June 15, September 15, and January 15 of the following year. Each payment must be sent with Form 592-Q, Payment Voucher for Pass-Through Entity Withholding.
In addition to quarterly payments, the trustee must file an annual reconciliation report using Form 592-PTE, Pass-Through Entity Annual Withholding Return. This form summarizes all withholding for all nonresident beneficiaries for the year and is due by January 31 of the following year.
By that same January 31 deadline, the trustee must also send Form 592-B to each nonresident beneficiary from whom taxes were withheld. This provides the beneficiary with proof of the tax prepayment.
The Beneficiary’s Role in the Process
The nonresident beneficiary must file a California Nonresident or Part-Year Resident Income Tax Return (Form 540NR). On this return, they report their California-source income from the trust and calculate their total state tax liability. The amount withheld, as shown on Form 592-B, is claimed as a tax payment credit.
The beneficiary must attach a copy of Form 592-B to their tax return as proof of the payment made on their behalf. If the amount withheld exceeds the actual tax liability, the state will issue a refund. If the tax liability is greater than the amount withheld, the beneficiary must pay the remaining balance.