The Use of Trusts to Lower State Income Taxes

Law Firm Newswire




Roseville, CA (Law Firm Newswire) March 27, 2017 – The majority of tax strategies focus on lowering federal income taxes because they make up the largest amount of taxes that someone could owe.

However, in some states, income tax rates are considerably high, and can be a substantial addition to tax bills. One solution is to establish a trust in such a way that prevents it from being subject to state income tax.

For the past 10 years, affluent individuals, families and their advisors have been using incomplete non-grantor (ING) trusts to reduce their exposure to state income taxes. The ING trusts can move the tax exposure from a state with tax rates, such as California, to one with no income tax, such as Delaware, Florida, Nevada, Texas and Wyoming.

According to prominent estate planning attorney David Wade, “ING trusts can serve as a valuable estate planning vehicle to minimize the amount of state income tax to which property is exposed. However, it is best to consult an experienced trust and estate attorney who can counsel you as to how to use such trusts.”

Two kinds of trusts exist: grantor and non-grantor. While grantor trusts transfer all of their tax exposure to the individual who established the trust, non-grantor trusts, in which the person who created the trust, relinquishes control of the trust, do not.

In addition to a federal tax, trusts are subject to state income tax, and a beneficiary must pay federal and state income tax on any funds they receive. However, states can only assert a claim of state income tax if they can prove a substantial association with the income. This is referred to as nexus. In California, the current income tax rate for the highest bracket is 13.3 percent.

Each state has its own regulations concerning which trusts they deem to be residents of their state. For instance, Maryland considers a trust to be a resident if it is managed in the state. In New Jersey, the identity of the grantor is the determining factor. And in California, the trustee and beneficiary are considered in deciding whether the trust resides in the state.

Some estate planning attorneys engage in what is called jurisdictional planning to assist wealthy families in reducing or avoiding exposure to tax from their home state. For instance, a trust that is situated in a high-tax state, such as New Jersey, can avoid state income taxes by applying a different structure. Replace the New Jersey trustee with a trustee from Delaware.

Establishing ING trusts is a relatively new strategy that has become more popular throughout the last 10 years, in avoiding state income taxes. Incomplete non-grantor trusts can help affluent individuals minimize the state income tax at the trust level, especially if they are on the verge of realizing a considerable gain.

Consider the case of an engineer at a computer company in California who is thinking of retiring in the near future. He owns $10 million in stock options, which will figure prominently in his retirement plan. Since his cost basis is low for the options, the entire amount will be subject to state income tax. However, if he establishes an ING trust in Nevada one or two years prior to the transfer of the stock options, he can avoid payment of the California income tax on the gain. The tax bill would be in excess of $1 million.

Estate planning experts advise that anyone applying this strategy should take certain measures to avoid being perceived as trying to evade the payment of taxes. Business owners who use trusts prior to the sale of a business should have them in place before there is any letter of intent or talk of selling.

Learn more at Wade Law Offices 2400 Professional Drive Suite 100 Roseville, CA 95661 Phone: (800) 835-2634 Wade Law Offices Blog
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