Especially given President Trump’s tax plan that would get rid of the federal income tax deduction for state income taxes paid, planning to save state income taxes should be a significant and necessary part of the estate planning process for all advisors.
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.
The 3rd Annual 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 by moving and fixing any existing trusts that are needlessly paying state income tax and therefore dragging down the trust’s asset base.”
Frequent LISI contributor Steve Oshins, Esq., AEP (Distinguished) authors three different annual state rankings charts and one state income tax chart:
Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. Steve is a nationally known attorney who was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He is listed in The Best Lawyers in America®. He has written some of Nevada's most important estate planning and creditor protection laws. Steve can be reached at 702-341-6000, x2 or at soshins@oshins.com. His law firm's web site is http://www.oshins.com.
EXECUTIVE SUMMARY:
It is wasteful to accumulate income in a non-grantor trust that is subject to state income tax on income that is not sourced to a state with a state income tax. Different states have different rules as to what creates a “resident trust” that is subject to taxation in that state.
The Non-Grantor Trust State Income Tax Chart was created not only to be a resource to practitioners and clients, but also to create opportunities for them.
What Causes a State Income Tax?
Some states tax a testamentary trust that is set up in the Will of the resident testator. Some states tax an inter vivos trust set up by a resident of that state. Some states tax a trust that is being administered in that state. Some states tax a trust if there is a resident trustee. Some states tax a trust if there is a beneficiary who is a resident of that state. Some states tax a trust based on a combination of these factors.
One focus of this Chart is to determine whether a trust can be moved to another state in order to save state income tax. Another focus is to determine who to avoid using as trustees, in which states to avoid trust administration, as well as other variables that may unnecessarily cause a state income tax.
COMMENT:
I. 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.
No trust should ever be created without the advisor knowing the residency of the settlor, the proposed trustees and the beneficiaries. This information is invaluable in the planning process since it can have a substantial influence on the decision points.
Thus, each advisor should have a handy resource to use to quickly access the different state rules in order to be able to properly plan for their clients.
II. President Trump’s Tax Plan
President Trump’s tax plan seeks to reduce the federal income tax rates, but at the same time get rid of most income tax deductions while preserving the mortgage income tax deduction and the charitable deduction. The reduction of income tax deductions is necessary to, in part, help pay for the loss of federal tax revenue caused by the lower tax rates and therefore may be a necessary part of the tax plan.
One key income tax deduction that would be lost is the deduction for state income taxes paid. For residents of states with a high state income tax rate, this is a large deduction that will have a substantial effect on their after-tax income.
The loss of this deduction magnifies the benefits in saving state income taxes using the concepts summarized in the Chart and therefore, if passed as part of Trump’s tax package, will increase the benefits of using these concepts.
III. The 3rd Annual Non-Grantor Trust State Income Tax Chart
The 3rd Annual Non-Grantor Trust State Income Tax Chart is a two-page summary of the non-grantor trust state income tax rules in all states and Washington, D.C. The states are listed in alphabetical order. [If your computer still shows the 2nd Annual Chart at this link, clear your computer’s cashe in order for it to be updated, or simply email Steve Oshins at soshins@oshins.com and request the chart by email.]
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Column 1 lists the name of the state.
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Column 2 lists the statute or other taxing authority showing what it takes to be treated as a resident trust. For those who access the online version, the statute or taxing authority is linked so that the end-user can easily access that authority in order to read the rules carefully. This feature will help those who were unsure how to spot the opportunity to very easily go directly to the source.
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Column 3 lists the highest tax rate for 2017 in that jurisdiction.
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Column 4 answers the question, “Under What Condition does the State Tax a Non-Grantor Trust?” It answers it in a very short summary fashion so the reader can quickly understand the gist of the statute or other taxing authority. There is a warning towards the bottom of each of the two pages not to rely on the short summary and to always read the statute.
IV. The 2017 Tax Rate Changes
A number of states changed their highest state income tax rate for 2017. These changes are summarized as follows:
1. Indiana reduced its top income tax rate from 3.3% to 3.23%.
2. Maine increased its top income tax rate from 7.15% to 10.15%.
3. North Carolina reduced its top income tax rate from 5.75% to 5.499%.
V. Minnesota Taxation – Fielding v. Commissioner of Revenue (May 31, 2017)
In a recent case out of Minnesota, Fielding v. Commissioner of Revenue (May 31, 2017), the Minnesota Tax Court held its state income tax long-arm unconstitutional as applied to four irrevocable trusts settled by a Minnesota grantor. Minnesota’s statute taxes all post-1995 irrevocable trusts based solely on the residency of the grantor being in Minnesota.
Three of the four trusts have no Minnesota beneficiaries. There were no Minnesota trustees. According to the law firm that won the case, the Department of Revenue may appeal the decision.
This is not the first state to have a successful constitutional challenge for a statute taxing the trust solely based on the residency of the grantor. However, it is a significant 2017 case.
VI. How to Fix the State Income Tax Problem
It is often relatively simple to fix the state income tax problem.
Removal/Resignation: It might be as simple as having the trustees who are in a state that causes the trust to be taxed to resign or, if the trust agreement allows for it, to remove and replace them.
Decanting: Another way to potentially modify the trust to avoid state income tax is to have the distribution trustee decant the trust either by using that state’s decanting statute, if there is such a statute, or, if the trust agreement has decanting language, by using the decanting language in the trust agreement. If neither exists, then if the trust has a change of situs provision, the trustee or trust protector can change the situs to a state with a flexible decanting statute and then decant it
Nonjudicial Settlement Agreement: Yet another way to potentially modify the trust to avoid state income tax is to utilize any statutory authority in that state, such as a nonjudicial transfer of trust situs to change situs and modify the trust by following the statutory rules.
Court Petition: Finally, if all else fails, the trustee can petition the local court for authority.
VII. States Taxing a Trust Solely Based upon Residency of the Settlor/Testator
Modifying the ongoing state income tax might be next-to-impossible if the state taxes a trust solely based on the residency of the settlor or testator. This might require a court challenge to the constitutionality of the taxing statute. This has been successfully done in some of these states, such as in the Fielding case noted above, but generally is only done for families with substantial assets who can afford to pay for such a challenge.
VIII. Conclusion
Especially given President Trump’s tax plan that would get rid of the federal income tax deduction for state income taxes paid, planning to save state income taxes should be a significant and necessary part of the estate planning process for all advisors.
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.
The 3rd Annual 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 by moving and fixing any existing trusts that are needlessly paying state income tax and therefore dragging down the trust’s asset base.
Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, with clients throughout the United States. He is listed in The Best Lawyers in America®. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and was named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has authored many of the most valuable estate planning and asset protection laws that have been enacted in Nevada. He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website,www.oshins.com
