Taxes
Looking to reduce or eliminate state taxes on your trusts? It's possible.
Where a trust “lives” might make a big difference financially to your beneficiaries.
Do you want to make sure that more of the assets you plan to give to your family (and the income those assets earn) actually gets to them?
Then you might want to take some steps to help ensure that the non-grantor trusts you create pay as little as possible in state income taxes.
One such step could be to reduce, if not eliminate, the trusts’ duty to pay any state income taxes. This feat might be arranged simply by making sure the trustees of your (new and/or already established) non-grantor trusts reside in the “right” state or that the trust owns only the right kind of assets.
What types of trusts owe state income taxes?
For U.S. income tax purposes, there are two types of trusts:
- “Grantor trusts”—The person who created the trust (the grantor), or his or her spouse,1 retains sufficient powers over the trust that he or she is deemed to own the assets and therefore must pay any taxes on any income the trust earns and any gains it recognizes. This is the case even if the creator (or grantor) of the trust has forever and irrevocably relinquished the right to benefit from the trust’s assets.2
- “Non-grantor trusts”—The trust itself is considered the owner of the assets in the trust. Consequently, the trust itself must pay taxes on the income it accumulates and the gains it recognizes. (This type of trust is often created upon the grantor’s death.)
Meanwhile, state tax law governs how much—and even whether—a specific non-grantor trust must pay in taxes to that state.
Yes, it can get complicated
We’re talking about taxes, so of course there are complications:
Management matters
How a trust is managed can make a difference. Non-grantor trusts don’t always owe taxes even when they “live” in a state that generally taxes “resident” non-grantor trusts.
For example, if a trust pays all of its income annually to a beneficiary, its net income could be close to zero. As a result, its state income tax burden could be relatively small. (In that case, the beneficiary would owe tax on the income the trust had earned, based on the beneficiary’s state of residence.)
What’s in the trust matters
Even if a trust “lives” in a state that does not tax income at all, the trust might still owe taxes to another state, one that does tax income.
For instance, if a trust owns real property, or an interest in a “pass-through” entity (such as a partnership) that does business in a state with income taxes, the trust may owe taxes to that state on the income the property or business earns.
Where the beneficiaries live can matter
Some states, such as California, look at the beneficiaries’ residence when determining whether, and to what extent, to tax trust income.
Meanwhile, New York has a “throwback” tax that, in certain circumstances, can subject New York resident beneficiaries to tax on income earned by some non-grantor trusts in earlier years.
You might be able to do something about that tax bill
Sometimes (though certainly not always), all you need to do to reduce or eliminate state-level taxes on non-grantor trust assets is to simply replace all trustee(s) residing in states that have an income tax with trustees (plus any other fiduciaries) with trustees and other fiduciaries who are residents of another state.
Of course, it is not easy to find capable and trustworthy trustees in any state. That is why many corporate fiduciaries such as J.P. Morgan who can serve as trustees have trust companies in tax-friendly jurisdictions.
For example: Let’s assume Grace,3 a New Jersey resident, at her death funds a $5 million trust for the benefit of her only son, Frank. Grace’s sister, Lily, also a New Jersey resident, is the sole trustee. This trust allows the trustee (Lily) to accumulate or distribute income and principal to the beneficiary (Frank). But Frank is well off and does not need any income from the trust.
Option 1—Pay a lot in state taxes
Let’s say the trust invests exclusively in a portfolio of publicly traded stocks and bonds and earns $300,000 in taxable income. Lily distributes none of the income to Frank. Result: The trust would owe around $19,000 to New Jersey in income taxes.
Option 2—Pay no state taxes
Let’s take the same scenario but make someone other than Lily trustee. Let the trustee be someone who lives in New York, or J.P. Morgan, which has a trust company in Delaware. The result then would almost surely be that the trust owes no state income taxes—not to New Jersey, and probably not to the state of the trustee’s residence.4
Not for taxes alone
Residence alone should not govern your decisions about who should be the trustee (and other fiduciaries) of the trusts you create.
Rather, when you pick a trustee, it should be because your answer to this question is “Yes”:
- Does this person (or professional) have the time, willingness, capabilities and longevity to discharge a trustee’s many and complicated duties over the life of the trust?
If all else is close to equal, you may want to consider choosing a trustee whose mere residence would save the trust, and ultimately your beneficiaries, money.
And if you already have a trust in a high-tax state, that condition almost certainly can be changed. The trustee’s lawyers usually handle the process of changing trustees, which modern trust agreements generally streamline. Of course, the cooperation of the existing trustees in any transition helps. So too would be the cooperation of courts, which would almost always be involved in the succession process for trusts created under the terms of a decedent’s Will.
We can help
All decisions about trustees should be made in consultation with your tax advisors and estate planning lawyers.
Your J.P. Morgan team is available to work closely with them—and you—to help you ensure the choices you make today support the long-term goals you have for yourself and your family.
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