The location of a trust matters a lot, especially from the perspectives of taxes, duration, and asset protection.
I. State Income Tax
Let’s start with taxes. “SALT” refers to state and local taxes.
The more SALT that applies to your trust, the less its value for your beneficiaries. Some states do not tax the income of non-grantor trusts, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Washington, and Wyoming. Other states vary widely on how they determine whether to tax trust income and on the rate of the tax. States generally consider any variety of the following factors when determining whether to tax trust income: (1) the residency of the grantor; (2) the administration of the trust; (3) the residency of the trustee; and (4) the residency of the beneficiaries.
Let’s consider two examples.
New York taxes non-grantor trusts created by a grantor while a resident of New York, with a highest tax bracket of 10.9%. However, New York exempts such trusts from taxation if: (1) the trustee resides outside of New York; (2) no trust assets are located inside New York; and (3) the trust has no New York-source income, such as revenue from a business or a rental property located in the state.
California has the highest taxes in the US for trust income – the tax is up to 37% on amounts over $14,450. This is in addition to federal taxes on trust income. California always taxes a trust on its California-source income. California also taxes a trust based on the residency of the trustee. Non-California-source income also will be subject to California’s income tax if a trustee or beneficiary is a resident of California.
II. State Estate & Inheritance Taxes
Seventeen states and Washington DC have estate or inheritance taxes.
Six states have inheritance taxes, which tax the beneficiaries receiving an inheritance. Here are those states, with the top inheritance tax rate for each state: IA (4%), KY (16%), NE (15%), MD (10%), NJ (16%), and PA (15%). The tax rates are tiered, and these states exempt some beneficiaries or tax them differently, depending upon their relationship with the deceased. If you’re expecting a large inheritance and you live in one of these states, you might consider moving to a different state – depending on your relationship with the anticipated benefactor.
The estate itself must pay estate taxes. Here are the states with estate taxes and the top tax rate for each state: CT (12%), DC (16%), HI (20%), IL (16%), ME (12%), MD (16%), MA (16%), MN (16%), NY (16%), OR (16%), RI (16%), VT (16%), WA (20%). These taxes apply to the estates of persons who die in those states, and sometimes to property located in those states. If you have a large estate and wish to avoid these taxes, you might consider moving your residence and your assets to another state. States tax amounts over each state’s estate tax exemption amount. The exemption amounts vary from a low of $1 million in Oregon to $12.92 million in Connecticut, which matches the federal exemption amount. These state taxes are in addition to the federal estate tax, which applies a top rate of 40%.
III. State Limits on Trust Duration
Dynasty trusts intended to last for generations must be established in states that allow trusts to last longer.
Laws governing how long a trust can last vary widely from state to state. Many states have laws limiting trusts to about 100 years at the most. We won’t get into the details of that – it’s called the Rule Against Perpetuities, and it’s quite complicated. These laws make most states bad choices for a Dynasty Trust with long-term goals. Other states have enacted laws allowing trusts to last much longer. For example, a trust can theoretically last forever in South Dakota or Alaska, 1,000 years in Wyoming, 365 years in Nevada, 360 years in Tennessee, or 300 years in Texas.
IV. States with Asset Protection Trusts
Several states now allow Domestic Asset Protection Trusts or DAPTs. If you want to establish a DAPT, you have to do it in one of these states.
States authorizing DAPTs have passed laws allowing a grantor to establish a trust in which the grantor is also a beneficiary, but the trust assets are protected from the claims of the grantor’s potential creditors. Here is a list of states with such laws: AK, DE, HI, MI, MS, MO, NV, NH, OH, OK, RI, SD, TN, UT, VA, WV, WY. DAPTs cannot be established in other states.
Offshore or Foreign Asset Protection Trusts – which provide another level of asset protection – can be established in other countries, including the Caymen Islands or the Cook Islands.
V. Miscellaneous Considerations
Other location considerations include the states’ privacy protection laws – or lack thereof – and the convenience and expense of administering a trust in that state.
Note also that a well-drafted trust allows for moving the trust situs if local laws change or other factors make a new location more advantageous.