When Does a Charitable Remainder Trust Owe State Tax on the Sale? New Jersey and Pennsylvania, Four Mechanisms, and the Checks That Belong Before Funding

Short answer. Federal qualification under § 664 is not a state exemption. New Jersey and Pennsylvania each treat an ordinary CRAT or CRUT as a taxable trust rather than an exempt charitable trust, and each taxes the trust on sale gain retained in the year of the sale. On a $2 million unitrust funded with property carrying $1.6 million of gain and paying five percent over twenty years, that costs roughly $128,000 in New Jersey and roughly $46,000 in Pennsylvania, against nothing in a conforming state — and because the money leaves the corpus at inception, the New Jersey figure displaces close to $300,000 of distributions and remainder across the term. This article covers the jurisdictions researched and is not a fifty-state survey.

Jurisdiction: Federal, with New Jersey and Pennsylvania overlays and California and Massachusetts as limited contrastsPrimary Statutes: IRC §§ 664(b), 664(c), 170, 2055, 2106, 2522; Treas. Reg. § 1.664-1; N.J.S.A. 54A:2-1, 54A:5-3; 72 P.S. §§ 7301(s), 7305; Cal. Rev. & Tax. Code §§ 17651, 17755; Mass. Gen. Laws ch. 62, § 11Key Authorities: Burke v. Director, Div. of Taxation, 11 N.J. Tax 29 (Tax 1990); The Jacob & Alice Klein Charitable Remainder Unitrust v. Director, Div. of Taxation, Docket No. 006284-2020 (N.J. Tax Ct. June 4, 2026); McNeil v. Commonwealth, 67 A.3d 185 (Pa. Commw. Ct. 2013); N.J. Div. of Taxation TB-64 (2009), GIT-12 (rev. 01/26), TAM-2010-5; Pa. Dep’t of Revenue PIT Guide (Estates, Trusts and Decedents; Deductions and Credits); PA-41 Schedule DD instructions; Mass. Dep’t of Revenue Letter Ruling 81-88Last Reviewed: July 2026Category: State Fiduciary Income Taxation

By Klaus Gottlieb, Esq.

Scope. This article establishes the published treatment of charitable remainder trusts in New Jersey and Pennsylvania and sets out the framework to apply elsewhere. No conclusion about an unexamined state should be drawn from that state’s use of federal terminology or from the absence of CRT-specific guidance. Silence is not conformity.

What § 664(c) exempts, and what it does not reach

The trust-level exemption and the post-2006 UBTI rule

IRC § 664(c)(1) provides that a qualifying charitable remainder annuity trust or charitable remainder unitrust is not subject to any tax imposed by subtitle A of the Code. Treasury Regulation § 1.664-1(a)(1)(i) states the same rule.

For taxable years beginning after December 31, 2006, unrelated business taxable income no longer revokes that exemption for the year. Section 664(c)(2) instead imposes a chapter 42 excise tax equal to the trust’s UBTI. Regulatory language written before that amendment still speaks of the exemption being unavailable in a UBTI year, and it should be read against the current statute.

The operative phrase is “tax imposed by this subtitle.” Subtitle A is the federal income tax. A state fiduciary income tax is imposed under state law. Federal qualification answers the federal question and leaves the state question open.

What happens to gain after a trust sale

A lifetime contribution generally carries the donor’s basis into the trust. When the trustee later sells appreciated property in a sale respected as the trust’s own, the exempt trust ordinarily pays no federal income tax on realization, and the gain is recorded in the § 664(b) tier accounts. Distributions to a noncharitable recipient are then characterized in the statutory worst-first sequence: ordinary income, capital gain, other income, corpus, with further classes and rates preserved inside the first two tiers.

Sale gain is therefore recognized by the recipient as later payments reach the capital-gain tier. It does not follow that every dollar of gain is eventually taxed to a private recipient. Section 664(b) governs the character of what is distributed; it does not require accumulated tier balances to be exhausted before the trust terminates. Some accumulated gain can remain in the trust when the remainder becomes possessory in the charity. The accurate statement is that the federal regime defers trust-level tax and may spread recognition at the beneficiary level over the term.

Which charitable deduction is at issue

Treas. Reg. § 1.664-1(a)(1)(iii)(a) defines a charitable remainder trust by reference to a deduction allowable under § 170, § 2055, § 2106, or § 2522. Depending on the transfer, the federal benefit is an income-tax, estate-tax, or gift-tax deduction. Three deductions run through this analysis and should never be merged: the donor-level deduction for the remainder interest, the trust’s annual deduction for amounts distributed or credited to beneficiaries, and the trust’s deduction for amounts permanently set aside for charity. Each has its own state answer.

Why a state result cannot be read off the federal return

It is tempting to reason that a state beginning with federal taxable income automatically receives a zero base from an exempt CRT. That shortcut does not survive contact with the filing regime. A section 664 trust does not file Form 1041; it files Form 5227, maintains statutory tier accounts, and may carry UBTI or other separately treated items. There is no ordinary taxable-income line propagating outward to state returns.

The inquiry is not where the state computation begins. It is whether state law, read as a whole, recognizes the federal exemption, modifies it, supplies an independent exemption, or taxes the trust under its own fiduciary rules. Forms and instructions show how a department administers the answer; statutes and controlling cases supply it.

New Jersey taxes a charitable remainder trust on retained gain

Burke, TB-64, and GIT-12

N.J.S.A. 54A:2-1 imposes the Gross Income Tax on every individual, estate or trust other than a charitable trust or a qualifying pension or profit-sharing trust. Section 54A:5-3 allocates between trust and beneficiary: broadly, the trust is taxed on income and gain not distributed or credited to beneficiaries, and beneficiaries are taxed on amounts distributed or credited to them.

The Act does not define “charitable trust.” In Burke v. Director, Division of Taxation, 11 N.J. Tax 29 (Tax 1990), the Tax Court construed the term to mean a trust devoted exclusively to charitable beneficiaries. The Division of Taxation adopted that construction in Technical Bulletin TB-64 (June 29, 2009), which states that a charitable remainder trust is not exempt under 54A:2-1 because the governing instrument permits noncharitable beneficiaries to receive income or gain, and that income neither distributed nor permanently and irrevocably set aside or credited to charity is taxable to the trust. The Division’s current GIT-12 (rev. 01/26) continues to treat CRTs as subject to New Jersey fiduciary filing rules.

TB-64 and GIT-12 are administrative guidance. Their weight here rests on Burke and now on Klein.

What Klein cost

In The Jacob & Alice Klein Charitable Remainder Unitrust, Ilana Kahn, Trustee v. Director, Division of Taxation, Docket No. 006284-2020 (N.J. Tax Ct. June 4, 2026), a twenty-year CRUT paying a seven percent unitrust amount challenged the Division’s position directly and argued that Burke was wrongly decided.

For 2015 the trust reported roughly $6.01 million of short-term gain from the disposition of property and a unitrust amount of $388,471 distributed. It had paid $450,172 of estimated Gross Income Tax, reported no tax due, and claimed the full amount as a refund. The Division computed tax on the reported net income at approximately $47,100 more than the refund claimed and billed the difference. The trust then amended to remove $6,023,217 of gain on the ground that § 664(c) exempted it. The Division denied the claim.

The Tax Court granted summary judgment to the Division. It followed Burke, held that a CRT with private unitrust recipients is not an exclusively charitable trust, and declined to import § 664 into the Gross Income Tax Act, observing that the Act was not patterned wholesale on the Internal Revenue Code and that the Legislature has incorporated particular federal provisions when it intended to. Klein is a published Tax Court opinion. Given its recency, appellate status should be confirmed before it is relied on as settled.

Acceleration, not duplication, is the injury

The Klein court answered the trust’s double-taxation argument by pointing to 54A:5-3, under which a beneficiary may exclude income on which the trust has paid New Jersey tax when the statutory conditions are met. That anti-duplication rule should not be overstated: whether trust-level and beneficiary-level amounts match in character, year and amount is a return-preparation question rather than an assumption.

The clear injury is timing. Tax paid by the trust in the sale year leaves the investment base permanently. Even where New Jersey ultimately avoids taxing the same item twice, the trust loses the use and the compounding of dollars that federal law would have left invested across the term.

Residence, nexus and source are three separate questions

New Jersey classifies an inter vivos trust by the transferor’s domicile when the trust became irrevocable, and a testamentary trust by the decedent’s domicile at death. GIT-12 nevertheless recognizes that a statutory resident trust lacks sufficient nexus and is not subject to tax where it has no New Jersey tangible assets, no New Jersey source income, and no New Jersey trustee or executor, with a fiduciary return and certification still required.

Separately, a nonresident trust may be taxed on New Jersey source income, including gain from New Jersey real or tangible property. Moving administration does not move the land.

Pennsylvania reaches the same result, and Schedule DD does not rescue an ordinary CRT

A CRAT or CRUT is not a Pennsylvania charitable trust

The Department of Revenue’s Personal Income Tax Guide chapter on Estates, Trusts and Decedents states that a federally qualified CRAT or CRUT is not a Pennsylvania charitable trust where any part of retained earnings may benefit a private individual in a later year, or any part of the trust’s income is required to be, or actually is, distributed or credited to a private individual. An ordinary CRT therefore files the PA-41 and is subject to Pennsylvania’s rules for estates, trusts and beneficiaries. Under 72 P.S. § 7305 and the Department’s guidance, the trust is generally taxed on income and gain not required to be distributed and not actually paid or credited to a beneficiary.

The invasion-of-corpus rule

PA-41 Schedule DD implements both the deduction for amounts distributed or credited to beneficiaries and the deduction for amounts set aside for charity. The set-aside standard is strict: the possibility that the amount will not be used for the charitable organization must be so remote as to be negligible.

The Schedule DD instructions supply the governing example. Where there is a possibility that the corpus of a charitable remainder trust may be invaded to make payment of the annuity amount or unitrust amount, the trust may not take the deduction. A conventional CRAT and a standard CRUT both permit payment from corpus when current income is insufficient. The actuarial charitable remainder should not be presented as a deductible annual set-aside on that basis. A deduction remains possible only to the extent a specific amount is segregated, permanent, unconditional and beyond any private use, which is a question for the governing instrument rather than the federal illustration.

Beneficiary characterization does not track § 664(b)

Pennsylvania does not copy the federal four-tier character of a CRT distribution onto the beneficiary’s return. The Department treats amounts derived through estates or trusts as a separate Pennsylvania class of income; a distribution generally does not retain the classification it carried inside the trust, though it retains its source. The fiduciary reports beneficiary amounts on Schedule DD and PA Schedule RK-1 or NRK-1. The federal Form 5227 tier statement and the Pennsylvania beneficiary schedules serve two different systems, and both must be prepared.

McNeil separates classification from constitutional nexus

Section 7301(s) classifies a trust as resident by reference to the residence of the settlor, transferor or decedent at the creation or transfer event. That historical classification can persist after administration moves. It does not establish Pennsylvania’s constitutional power to tax all of the trust’s income.

In McNeil v. Commonwealth, 67 A.3d 185 (Pa. Commw. Ct. 2013), two inter vivos trusts created in 1959 by a Pennsylvania settlor were governed and administered under Delaware law with a Delaware corporate trustee. In the year at issue the trusts held no Pennsylvania assets and had no Pennsylvania source income; their only Pennsylvania contact was the residence of discretionary beneficiaries. Applying the Complete Auto framework, the Commonwealth Court held that imposing Pennsylvania personal income tax on all of the trusts’ income violated the Commerce Clause on those facts, and reversed.

Pennsylvania analysis therefore requires three questions kept apart: statutory resident classification, Pennsylvania source income, and constitutional nexus with apportionment. Resident classification alone does not carry all-source tax forever.

What the overlay costs on a representative unitrust

Take a client contributing a long-held rental property worth $2,000,000 with an adjusted basis of $400,000 to a five percent unitrust for a twenty-year term. The trustee sells in the first year, which is what a real-estate-funded unitrust is built to do: the object of the structure is to convert an undiversified, management-intensive asset into a diversified portfolio, and the trustee moves as soon as a sale can be arranged on the trust’s own terms. The trust realizes $1,600,000 of gain and distributes a first-year unitrust amount of $100,000, leaving roughly $1,500,000 of gain retained at the trust level. That retained figure is the state tax base in both non-conforming states.

	New Jersey	Pennsylvania	Conforming state
Rate applied to retained gain	Graduated to 10.75% over $1,000,000	3.07% flat	—
Sale-year tax at the trust level	About $128,000	About $46,000	None
As a share of the funded value	6.4%	2.3%	—

The tax figure understates the injury, because those dollars never rejoin the corpus. Assume the trust earns six percent while paying out five, so the corpus compounds at roughly one percent. The $128,000 taken in New Jersey would otherwise have produced about $141,000 in additional unitrust payments across the twenty years and left about $157,000 more for the charitable remainderman — close to $300,000 of nominal value from a single year’s tax. Pennsylvania’s lower rate produces the same shape at roughly a third of the magnitude.

The point is not the precision of any one figure. It is that a state overlay of six percent of funded value, taken at inception, is not a rounding error in a structure whose entire premise is that the sale proceeds stay invested. Rates and thresholds move, and these should be recomputed for the actual year of sale rather than carried forward.

Four mechanisms by which state law reduces CRT economics

Mechanism	New Jersey	Pennsylvania
Trust-level tax on retained sale gain	Yes — not a charitable trust under 54A:2-1 (Burke; Klein)	Yes — not a Pennsylvania charitable trust; PA-41 required
Trust-level charitable set-aside relief	Only for amounts permanently and irrevocably set aside or credited to charity	Denied where corpus may be invaded to make the annuity or unitrust payment
Source tax on in-state real property gain	Reachable against a nonresident trust	Reachable against a nonresident trust
Donor-level state charitable deduction	None generally available (TAM-2010-5)	None listed under the personal income tax
Limit on residence-based taxation	Administrative no-nexus rule (GIT-12)	Constitutional limit (McNeil)

Nonconformity with the trust-level exemption is the mechanism that does real damage, because it removes tax from the trust in the realization year. Source taxation operates independently of where the trust sits: a property state may tax gain from in-state real or tangible property whatever the governing-law clause says. The absence of a donor-level state deduction means the state value of the contribution must be modeled separately rather than inferred from a blended marginal rate. New Jersey allows no general Gross Income Tax charitable deduction, as the Division stated in TAM-2010-5 and as its list of allowable deductions confirms; Pennsylvania’s Deductions and Credits guidance lists none either. Residence classification is fixed by a historical event, while source, nexus and apportionment are tested on current facts.

Two contrasts: California and Massachusetts

Cal. Rev. & Tax. Code § 17755 exempts a qualifying CRAT or CRUT from tax under the Personal Income Tax Law, subject to a modified UBTI rule. For taxable years beginning on or after January 1, 2014, California does not adopt the federal § 664(c)(2) excise tax and instead subjects the trust’s UBTI to tax under § 17651. Federal law takes an amount equal to the whole of the UBTI; California taxes it under the fiduciary rate structure. The two consequences should not be conflated when screening an operating asset. See also the 2025 Form 541 booklet.

Mass. Gen. Laws ch. 62, § 11 provides that amounts distributed by a qualifying CRAT or CRUT have, in the recipient’s hands, the characteristics prescribed by § 664(b), and Letter Ruling 81-88 applies it. That is explicit adoption of the federal beneficiary-character rules. It is not, by itself, the source of a Massachusetts trust-level exemption, which is a separate question under Massachusetts fiduciary law.

What to check before funding

1. Confirm the federal sale posture. Whether the asset can be transferred before a sale becomes legally fixed, and whether debt, partnership, S corporation, REIT, REMIC or UBTI issues are present.

2. Identify every state with a claim. Settlor domicile, trustee and administration states, beneficiary states, asset situs, and business-source states.

3. Read the state’s CRT rule rather than its starting line. Explicit exemptions, conformity and decoupling provisions, fiduciary forms, and published guidance.

4. Separate residence from nexus. Determine statutory classification, then test source, contacts, constitutional nexus and apportionment.

5. Compute the trust-level distribution deduction for the sale year: what is required to be distributed, actually paid, or credited.

6. Test any charitable set-aside against the state’s own standard. An actuarial remainder is not a presently deductible set-aside.

7. Model beneficiary reporting separately. Whether the state adopts § 664(b), uses a separate trust-income class, allows an exclusion for previously taxed trust income, or requires withholding.

8. Value the donor deduction independently. Do not apply a blended federal-and-state rate unless the state allows the relevant deduction.

9. Model the cash drag. Sale-year state tax, later beneficiary tax, credits for taxes paid to other states, and the lost return on tax paid early.

10. Recheck authority before execution and again before sale. Forms, instructions, rates and appellate posture move.

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The client conversation

Where a state taxes the trust, the trust remains federally qualified and the plan remains sound in its charitable and income objectives. What changes is the year the tax falls due and the size of the base that stays invested. Deferral and reinvestment are one central benefit of a charitable remainder trust rather than the whole of it, and a state overlay reduces that benefit without removing the charitable transfer, the income stream, the diversification or the federal deduction.

The number worth putting in front of the client is the difference between the distribution stream with and without sale-year state tax. The CRUT Payout Path simulator models that stream across the term, and running it twice shows what the overlay costs.

This article is general information only. It is not tax or legal advice, and it does not create an attorney-client relationship. State taxation of trusts is highly fact dependent, published administrative guidance may be nonbinding, and statutes, forms, rates and appellate status should be confirmed as of the relevant funding, sale and filing dates. Consult counsel admitted in the relevant jurisdiction.