Receiving an IRA or family trust is an unwanted tax situation in California. Recipients might have assumed that some inherited funds from their out-of-state parent were beyond the purview of the State of California. However, the residency, beneficiary rules, income sources, and federal distribution rules can have complex implications.
In July 2026, California’s Franchise Tax Board issued Legal Ruling 2026-01, clarifying how contingent beneficiaries of discretionary trusts under the Revenue and Taxation Code Section 17742 are treated.
The ruling addresses the question of when a beneficiary’s interest is contingent or noncontingent and the impact on trust taxation. Look for an experienced professional (like an IRS tax lawyer in San Diego) who can help you with all the solutions.
Why Trust Beneficiary Status Matters?
California treats the income of a trust differently, depending on whether the trust’s fiduciaries and the beneficiaries of the trust are in California or not. California resident noncontingent beneficiaries have a broader base for the California taxation of trust income than do contingent beneficiaries.
It’s important when an out-of-state trust eventually pays income to a resident of California.
Legal Ruling 2026-01 offers three fact patterns involving discretionary trusts and resident beneficiaries and elucidates the California analysis of whether an interest is contingent.
The 10-Year Inherited IRA Rule
In general, the federal SECURE Act provides that most non-spouse beneficiaries of retirement accounts after 2019 will have 10 years to spend the entire balance of the account. The actual withdrawal requirements may vary based upon the classification of the beneficiary and whether the original owner is or is not at the required beginning date.
Withdrawals of large sums from an IRA can push other income into higher tax brackets and raise California adjusted gross income.
It’s not a “all or nothing” proposition
Reward Good and Bad Behaviour.
If the rules allow, beneficiaries may choose to withdraw the balance over the 10-year period rather than the entire balance in one go.
Consider:
- The present and future earnings.
- The marginal tax rates in California.
- Expected investment growth
- Future retirement income
- Potential changes in residency
When there are required minimum distributions, they are required to be taken. If required minimum distributions are required to be taken. Discuss your issue with a professional tax person (like an EDD audit attorney in Los Angeles) for a better understanding of your situation.
Consider a multi-year plan to prevent unnecessary focus on taxable income in one year.
Begin by Going Over the Rules for Accumulating Trust
There are rules in California that govern the income of trusts. Certain accumulation distributions are reported on Schedule J (541), and the treatment may vary in California compared to the federal rules. For qualifying situations, FTB Form 5870A might need to be used to compute the California tax for an accumulation distribution.
This implies that trustees should not assume that spreading out several years of accumulated income in a lump sum has the same effect on a trust as the federal computation.
Carefully Plan Your Charitable Doings
If you have larger inherited IRAs, there are ways to consider charitable options. While a Charitable Remainder Trust (CRT) may be able to generate income for a while and eventually benefit charity, it is a complicated and complex instrument that has legal and tax considerations.
A CRT is not a simple solution to California tax. All of the structure, assets, beneficiaries, distribution rules, and charitable requirements must be examined prior to making the gift. California is one of the states that specifically identifies CRTs as being out of the scope of ING-trust election rules.
Important California Considerations
Under California’s rules, retirement income from an individual retirement account (IRA) for non-residents is generally not taxed. Residency planning, however, may be important for California residents since they may be subject to tax on worldwide income.
Tips for Beneficiaries
- Clearly identify the residency of the person receiving the distribution when distributions are made.
- Determine if your trust interest is contingent or noncontingent.
- Check the trustee residency and California-source income for the trust.
- Simulate withdrawals from an inherited IRA over a number of years.
- Review Schedule J (541) and/or Form 5870A to see if either is applicable.
- Don’t change residency solely for tax purposes without professional advice.
- Align the trustee, estate attorney, and tax advisor prior to significant distributions.
The worst thing that can happen is that you mistake the distribution of an inherited IRA or trust for a lump-sum cash transaction. The trust provisions of California law and the federal 10-year retirement-account structure may have complex interactions. By taking the time to carefully time, accurately classify, and model the advance, beneficiaries can stay clear of unexpected surprises.
