Does Beneficiary of a Trust receiving K-1 with rental income pay State Taxes in the State the rental property is located in?

[Loonlaker]

I am a trustee distributing rental property income via a 1041 K-1 to a beneficiary.  Does the beneficiary have to file state tax returns in the states where the rental property income was generated?

[tagteam]

The answer would be dependent upon the particular state, but if the net income exceeds the threshold, then a return would be required; the income is sourced to the state in which the rental is located.

[pk]

@Loonlaker , generally the income generated by property is sourced to and therefore taxed by the state where the property is located. There may be layering of this and therefore  state tax on the income is "obfuscated" but somebody somewhere has to pay the taxes to that state where the property is generating the income.

Does that help ?

[guywong]

The short answer is Yes.  Since the trust generates income from the state where the property is located, the beneficiary who receives a proportionate share of the trust income has income sourced from that state and therefore is required to file an income tax return with that state.

Having said that, the amount of tax the beneficiary pays to the state where the property is located may be able to offset a substantial amount if not the entire amount of state tax paid from the tax s/he pays to the resident tax return as the income from the 1041 K-1 is also taxed by the resident state.  This way, there is no double taxation.  This is assuming the resident state has a state tax.  But if the resident state has no income tax, then the income is only taxed once anyway.

[ibar601]

The Trust pays the taxes on income earned from another state. The beneficiary receives benefits from the net income of the trust.

[Loonlaker]

Yes, that helps.  The K-1 doesn’t indicate where the rental income came from.  Does the beneficiary have to determine that and file state tax returns in the appropriate states?  Thanks!

[Loonlaker]

Great answer!  Thanks!

[guywong]

The fact that there is a K-1 from a fiduciary income tax return with income allocated to the beneficiary is an indication that the beneficiary has taxable income from that state.

I'm in CA and the CA is very explicit.  I believe most states K-1s do show the income is from a "domestic" source (note: in this case, "foreign" means another state, "domestic" means within the state).

Here's a link to the CA K-1, as you can see, the last column specifically reads, "California source amounts and credits"

https://www.ftb.ca.gov/forms/2022/2022-541-k-1.pdf

I just looked at the Massachusetts Form 2 a Form 2K-1.  It doesn't have such a column, so unless the Trust/Estate provides the beneficiary with a K-1 from another state, it would be safe to assume that the income is from Massachusetts.  It doesn't hurt, however, if you specifically inform the beneficiary that all the income are from within the state.

From MA

https://www.mass.gov/doc/2k1instrucionspdf/download

Nonresident Beneficiaries
If the beneficiary receiving income from an estate or trust is a nonresident of Massachusetts,
Massachusetts will only tax the beneficiary on income that is derived from Massachusetts sources. Where
an estate or trust derives income from both within and outside Massachusetts, it will be necessary to
determine what portion of the beneficiary’s share of income is from sources within and outside
Massachusetts so as to properly allocate and report the income on Schedule 2K-1.

[tagteam]

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@Loonlaker wrote:

The K-1 doesn’t indicate where the rental income came from...

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The federal K-1 would not, of course (the IRS does not care), but state K-1 would (assuming the trust were required to file a K-1 with the state).