Like a game of chess, lawyers and wealth advisors are saving their clients money by moving trusts to states with more attractive laws.
One chief reason: Skyrocketing state income taxes. Leonard J. Adler, managing director of the J. P. Morgan Private Bank in Palm Beach, Fla., is seeing a great deal of trust business lately move from New York and other high-income tax states to income-tax-free Florida.
Frequently, trusts are subject to income tax in the state where the grantor creates them, Adler explains. If the trust pays out income, this may not be a major issue. But a trust can owe a state money if it accumulates income or has significant capital gains.
"In New York City, you would pay state and city taxes, and (unlike on the federal level) they don't make a distinction between capital gains (now 15% federally) and ordinary income," he says.
If your client's only connection to New York is a New York trustee, he or she can escape New York income tax by changing the trustee to a Florida trustee, Adler said. But other states-particularly in the Midwest-might tax a trust based upon where the creator lived, even if there's no remaining connection.
So should you be advising your clients to move their trusts? There's no surefire answer.
State trust laws vary dramatically. Most rely on a smattering of case law and have little actual trust law on their books-particularly in the West, notes Michelle Clayton, legislative counsel for the National Conference of Commissioners on Uniform State Laws (NCCUSL) in Chicago. Her organization has drafted a Uniform Trust Code on which it is currently seeking comments from the public. A uniform trust code could make setting up a common revocable trust simpler and less subject to litigation
Endorsed by the Financial Planning Association, NCCUSL's Uniform Trust Code includes provisions that would allow modification of a trust without court approval, observes Bruno Graziano, analyst with CCH Tax and Accounting in Riverwoods, Ill. It also could open certain trusts to greater scrutiny from beneficiaries, increasing potential conflicts and litigation over trust management.
States that have adopted the NCCUSL code, or modified versions of it, include Kansas, Maine, Missouri, Nebraska, New Hampshire, New Mexico, Tennessee, Utah and the District of Columbia.
Although more New Yorkers may be changing the locations of their trusts to Florida, that state may not necessarily be the best place for them. Palm Beach wills, trusts and estates attorney Frank T. Pilotte says trusts also are leaving Florida and moving to other states. "A law in another state might be more protective of a trust by way of keeping creditors of a trust beneficiary away from the trust," Pilotte said.
Plus, other states have more attractive "rules against perpetuities," which govern how long trusts can last. "In Florida, we're up to 360 years. But you might be able to go to another state that says a trust can last 1,000 years, or another where there is no time limit."
Trust assets are big business for states. The Federal Deposit Insurance Corp. reports they tally $37.34 trillion.
Trust income, Graziano says, is subject to federal income tax. In 2004, those taxes range from 15% on the first $1,950 of taxable income to 35% on taxable income in excess of $9,550. Trusts might be able to escape state income taxes by locating in Alaska, Florida, Nevada, South Dakota, Texas, Wyoming and Washington. Washington trusts, though, could find themselves subject to a Washington business and occupation tax.
There's a federal generation-skipping transfer tax (GST), not limited to assets in trusts. But why shouldn't your client, if possible, avoid a state generation-skipping transfer tax? They can do it, Graziano says, in Alaska, Arkansas, Delaware, the District of Columbia, Georgia, Idaho, Kansas, Kentucky, Louisiana, Maine, Minnesota, Mississippi, New Hampshire, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Pennsylvania, South Dakota, Utah, Virginia, Wisconsin and Wyoming.
If perpetuity of a trust is a concern, Graziano says, Alaska, Delaware, Idaho, Illinois, South Dakota and Wisconsin have abolished the common law rule against perpetuities.
Tax experts note that more states are imposing new death taxes in the face of the January 1, 2005, effective date for the repeal of the federal credit for estate taxes paid to states. Next year, the federal credit is being replaced by a deduction. Because many states tied their tax directly to the amount of the federal credit, its phasing out means their estate taxes are being phased out, too. Many states in this position have moved to "decouple" their taxes from the federal credit and are imposing new estate taxes to avoid a loss of revenue.
Unfortunately, moving a trust to a more favorable jurisdiction, for whatever reason, can be expensive. Adler says a client can expect to pay at least a "few thousand dollars to as much as $25,000 a trust" if it has to go to court. "That's the extreme," Adler said. "The thing you have to keep in mind is every situation is different, depending upon how the trust is drafted, who the beneficiaries are and where they live."
Robert E. Temmerman Jr., trust and estate lawyer in the high income environs of San Jose, Calif., cites expense as one reason he doesn't change jurisdictions for many trusts. Moving a trust, he says, can run from $5,000 to $10,000 just for a competent attorney in the new jurisdiction. Then you need to find a corporate fiduciary in the new state to manage the trust. Based on a $1 million trust, that can run about 1.5% annually. A $5 million trust might run less than 1% annually.
"You have to do a thorough cross-benefit analysis," Temmerman says.
Despite issues that could favor a trust's move, you also need to watch carefully for other surprising wrinkles in state laws.
For example, Utah not only adopted a modified version of the NCCUSL Uniform Trust Code, but also recently passed a law offering the benefits of the new self-settled asset protection trusts. However, its asset protection law, pushed heavily by banks, requires that the trustee under the act be a Utah-based bank, according to Salt Lake City attorney Tom Christensen. Bank trustees, he says, could prove more expensive than an individual trustee.