Different states have different rules as to what creates a “resident trust” that is subject to taxation in that state. States may tax a trust based on the residency of the settlor or testator, based on whether there is a resident trustee or beneficiary or whether there is administration in that state, or for a combination of these factors and/or other similar factors.
So it isn’t as easy as simply situsing a trust in a state with no state income tax. You have to look at the state taxing statutes that may apply.
THE 6TH ANNUAL NON-GRANTOR TRUST STATE INCOME TAX CHART
The Non-Grantor Trust State Income Tax Chart simplifies this analysis by summarizing each state’s taxing rules and providing a hyperlink to the applicable taxing statutes. The Chart was created not only to be a resource to practitioners and clients, but also to create opportunities for them.DOWNLOAD CHART
THE TAX DRAG
The “tax drag” is the amount by which investment returns are reduced due to taxes. The opportunity to move a non-grantor trust to a jurisdiction where state income tax can be avoided often makes a substantial impact on the value of the trust’s underlying assets. By avoiding the tax drag inherent in a trust that is subject to state income tax, the trust grows in value much faster.
This planning opportunity is very well-known to many advisors, but yet it appears to be underused by most and should be considered whenever any trust is being planned and created and whenever an advisor is reviewing an existing trust to look for opportunities to help the client.
$10,000 STATE AND LOCAL TAX DEDUCTION (“SALT DEDUCTION”)
The 2017 Tax Cuts and Jobs Act created a new $10,000 limitation on the federal income tax deduction for state and local taxes paid. This hits residents of states with a high state income tax especially hard, thereby making it that much more important for estate planners to understand how and why a non-grantor trust is subjected to a state income tax and how to design new trusts and modify old trusts to avoid or reduce the state income tax hit.
There are various planning options available, including the following:
- Incomplete Gift Non-Grantor Trust (“ING Trust”) – This is an irrevocable trust in which transfers to the trust are incomplete for gift tax purposes, but complete for income tax purposes. These trusts are generally set up in Nevada or Delaware, however they can be set up in any state that has a Domestic Asset Protection Trust statute and no state fiduciary income tax.
- Non-Grantor Gift Trust for Descendants – This is an irrevocable trust in which transfers to the trust are complete for gift tax and income tax purposes. These trusts should be set up in a state that has no state fiduciary income tax.
- Non-Grantor Gift Trust for Spouse and Descendants – This is an irrevocable trust in which transfers to the trust are complete for gift tax and income tax purposes. It is sometimes referred to as a SLANT. In order to make it a non-grantor trust, it must require an adverse party to approve a distribution to a beneficiary. These trusts should be set up in a state that has no state fiduciary income tax.
- Non-Grantor Gift Trust for Settlor, Settlor’s Spouse and Descendants – This is an irrevocable trust in which transfers to the trust are complete for gift tax and income tax purposes. In order to make it a non-grantor trust, it must require an adverse party to approve a distribution to a beneficiary. Since this trust must qualify as a Domestic Asset Protection Trust, it should be set up in a state that has a Domestic Asset Protection Trust statute. The state also should not have a state fiduciary income tax.
The Non-Grantor Trust State Income Tax Chart is an easy-to-use summary that should open up opportunities for practitioners to save state income tax for their clients both with newly-created non-grantor trusts and by moving and fixing any existing non-grantor trusts that are needlessly paying state income tax and therefore dragging down the trust’s asset base. The $10,000 state and local tax deduction limitation magnifies this problem, thereby bringing state income tax planning into the spotlight.
Advisors should be taking advantage of the opportunity to avoid the tax drag inherent in many trusts that accumulate income that is subject to state income tax even if not sourced to that state. In fact, it is somewhat shocking that this concept isn’t the most talked about concept among the financial planners whose assets under management are ratably affected by this tax drag.
If you found this article interesting, you might also be interested in these other educational programs and products by Steve Oshins:
- Estate Planning Techniques in a Time of Low Interest Rates
- The Installment Sale to an Intentionally Defective Grantor Trust
- The Grantor Retained Annuity Trust: Significant Estate Tax Savings with Nearly Zero Gift Tax Risk
- Advanced-Level Estate Planning Sales & Marketing Kits
- Steve’s FREE State Rankings Charts
ABOUT THE AUTHOR
Steven J. Oshins, Esq., AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor. Steve was also named one of the Top 100 Attorneys in Worth and is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates Lawyer of the Year in 2012, 2015 and 2018 and Tax Law Lawyer of the Year in 2016 and 2020. He can be reached at 702-341-6000, ext. 2, at firstname.lastname@example.org or at his firm’s website, www.oshins.com.