January 27, 2022 – Ever fear you might be missing out on a good opportunity to save on income taxes by transferring assets to a trust in another state? You’re not alone. I’ve counseled more than a few clients suffering from a case of “trust FOMO (Fear Of Missing Out).”
Some may hear that a friend has set up a new kind of trust—and think they should also have that trust. Others working through a major event, such as selling a business, may convince themselves a trust is needed for the transition. And others, after reading about a trust development in the news, begin to believe that they’re missing out on a trend.
These inquiries generally involve setting up a trust in a tax-friendly state—some of the most popular states being Delaware, Nevada, South Dakota and Wyoming. Lately, these questions have been triggered by fears of higher federal and state taxes. But while these trusts may be an ideal solution for some clients, they include conditions that might make them impractical for others. Fortunately, there are alternative solutions.
So how do we determine if such a trust is right for you?
What are you trying to accomplish?
First, we need to take a broad look at what you’re trying to achieve. It’s true that having a trust in a tax-friendly state may lower income taxes, offer enhanced creditor protection, and permit a “forever” status (in the case of perpetual or dynasty trusts, or “trusts in perpetuity”).
But these benefits may mean you’ll have to sacrifice elsewhere, such as by relinquishing some or all control of your assets to a third-party trustee and forgoing the ability to withdraw the majority of those assets.
To understand your intentions, we can start by asking: How much do you plan to spend on yourself, gift to immediate and future heirs, and donate to charity?
Among income and estate tax mitigation, legacy creation, charitable giving, and creditor protection, what are your priorities? For most, it’s some combination of the five.
We also need to determine what you’re willing to do to mitigate taxes and protect your assets: Are you willing to move? How far are you willing to move? Are you willing to move your business to another state? What about relinquishing some or total control over a potentially large portion of your assets to an independent trustee?
What are your asset protection preferences?
Over the past 25 years, expanding theories of liability and a significant uptick in litigation have resulted in a stronger emphasis on asset protection planning.
For reasonable asset protection, we’ll need to consider how risky your job and lifestyle are, as well as how much is at stake. The more layers of asset protection you have, the more fortified you’ll be against a creditor who wins a judgment against your assets.
Trust-friendly states generally offer higher levels of asset protection. Additional layers such as a trust owning a Limited Liability Company (LLC) may increase the resilience of your liability shield. The downside of reinforced asset protection is that it may require you to give up some level of control to a third-party trustee.
Not everyone requires a trust. In fact, other solutions may offer adequate asset protection and flexibility. Start with the first level of protection: acquiring sufficient umbrella insurance. The next step would be to set up an LLC or Family Limited Partnership, which can offer strong asset protection and more control of the assets. Though laws vary by state, a creditor won’t easily be able to pierce the shield of either. Business owners may improve their protection by creating separate LLCs for the operating portion of their business and assets of the company as well as personal assets.
How important is tax mitigation?
Many trust-friendly states have no individual or corporate income tax—an obvious consideration for those whose main objective is tax minimization. There are several ways to take advantage of this mitigation.
You can move to the trust-friendly state. If you’re not willing to move, you can set up an Incomplete Non-Grantor Trust (ING). This trust is irrevocable and self-settled, meaning you can be a beneficiary and continue to receive funds—but only with the authorization of an independent trustee. The grantor may have a say in distributions but cannot have the sole power to distribute. Generally, a distribution committee is set up with the grantor, independent trustee, and sometimes other trusted family members.
Here are more considerations with an ING:
- A distribution from the ING to you may trigger income tax in your domicile.
- “Incomplete” refers to incomplete gift, meaning assets will be included in grantor’s taxable estate and will receive a step-up in basis at death. Funding the trust with low-basis assets you’d like to hold long-term is an ideal strategy.
- With a separate taxpayer ID, the estate would be subject to taxes in the ING’s state of domicile, but there may also be taxes in grantor’s resident state.
Lastly, proceed with caution when selling a business and don’t assume what others have. It’s not advisable to transfer your shares to a trust in an income-free state a mere few months before a sale. It may be a red flag to the IRS. A multi-year runway to do this transfer is ideal and, even then, you may want to pay an attorney for a private letter ruling from the IRS to ensure that you do not trigger grantor trust treatment.
Is perpetuity your true goal?
If you would like your assets to pass not only to the next generation but to many generations thereafter, a dynasty trust might be ideal. Certain trust-friendly states such as Nevada, Alaska, Delaware, and South Dakota (to name a few) allow a trust to exist for an extended period. A Wyoming Dynasty trust may last for 1,000 years!
You should bear in mind that documents associated with trusts intended to build legacies and benefit future generations need to be periodically reviewed to ensure that they continue to comply with laws as they change.
In conclusion, just because you have a case of “trust FOMO” doesn’t mean you’re missing out. First, determine what your objective is and whether a trust in a trust-friendly state actually addresses that objective. Then, decide whether or not you’re amenable to certain restrictions: Mitigating taxes and protecting assets may require giving up some flexibility and control. But no one should jump to conclusions—or start packing a bag. It may also be possible to accomplish you goals without using a trust-friendly state at all!
Disclosures
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. Please consult with your Advisor prior to making any Investment decisions. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2022 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
We do not give legal advice and recommend that clients consult their estate planning attorney for implementation. When selecting an attorney, research their background to ensure that they have experience in both asset protection and estate planning. A1214