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Sunday, October 27, 2013


As a practitioner in Florida, a state without a state individual income tax, planning for state income taxes is not an every day event. Nonetheless, it does come up on occasion, and of course, it is a regular issue for residents of states with such taxes.

Below is an overview and primer on a planning technique that has received some favorable private letter rulings. It generally involves the transfer of assets (oftentimes a highly appreciated asset) to a trust in an asset protection trust jurisdiction. The principal purpose of the arrangement is to avoid state income on income and gains from the asset.

Thanks to Stephen Liss of Barclays for much of the information for this primer, taken from his presentation on the subject in Boca Raton last week.

I. Benefits

     A. Avoid state income taxes on sale of appreciated assets and other investment earnings

     B. Asset protection

     C. Grantor retains access to gifted property via usual asset protection trust mechanisms

II. Elements

     A. Trust in an asset protection trust jurisdiction (e.g., Delaware, Nevada) that has no state income tax

          1. Delaware useful with its directed trust statute

     B. Non-grantor trust

          1. To avoid state income tax to the grantor under grantor trust rules

          2. Typically done by requiring an adverse party to have to consent to distributions to spouse or grantor (i.e., a trust beneficiary)

               a) Can have several beneficiaries and allow distribution only on consent of one of them

     C. Funding via incomplete gift

          1. To avoid transfer tax on funding of the trust

III. Detriments

     A. Need for a local trustee in the trust jurisdiction

     B. Costs

          1. Drafting

          2. Accounting/tax returns

          3. PLR cost, if sought

          4. Trustee fees

     C. Makes no sense if grantor will not already be in the highest federal tax bracket, per trust tax rate compression which will push the trust quickly into the highest income tax bracket. Saving state income taxes while increasing federal income taxes will diminish or eliminate the benefits of the planning

     D. Distributions of trust income to the grantor (or other beneficiaries) may still be subject to state income tax

IV. Watch

     A. Confirm qualification under state law to avoid income tax

          1. Some states, such as Illinois, Virginia, and Wisconsin may tax the trust or the settlor if the settlor was a resident there when the trust was established

          2. Some states will subject the trust to tax if there is a resident co-fiduciary

V. Candidates

     A. Grantor is in a high income tax state

     B. Grantor is in a high or the top federal income tax bracket

     C. Pending sale of a highly appreciated asset

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