Let’s Go Situs Shopping

Scotty and Caroline didn’t inherit their wealth. They created it over a lifetime of hard work, diligent savings and prudent investing. And within the disciplined lifestyle that created it, they expect to pass a significant estate to their grandchildren after moderate consumption throughout their golden years. 

Tax efficiency was a natural conversation starter as we engaged in their first estate planning discussions; both federal and state. As their assets pass into the next generation, their preference is to prudently disperse the funds over a period of time instead of all at once. And quite importantly, Scotty and Caroline intend for the funds to be used in a manner that makes a difference; one that instills values, inspires evangelical behaviors and rewards selflessness. 

After a bit of research and discussion, my New York friends perceived their first step was to consult with a local estate planning attorney to create a NY trust. So, they were a bit surprised when I said, “Why a New York trust? A trust is an instrument of state law, each state’s laws are different, and you are free to choose which ‘situs’ is best for you!” 

“Situs” establishes the essential, legal framework of the trust; all possibilities, and limitations, exist within that framework. And, as time passes and laws change as they often do, a properly drafted trust empowers the Trustee to shop for a more favorable situs as facts and circumstances surrounding the beneficiaries’ best interests emerge.

So, let’s go situs shopping. 

Federal Estate Taxes

Among the few consistencies in estate planning is the impact that contemporary politics seems to have on the relevance of federal estate tax conversations. When I first entered the industry 38 years ago, each American taxpayer had a $192,800 tax credit, sufficient for exempting $600,000 of federal estate taxes. Today, in the first 100 days of the second Trump Administration, that exemption equivalent sits at about $28 million per married couple.

This federal tax regime presents an optimal and potentially brief planning environment - until next year. The future of the exemption hangs very much in the balance of the 119th Congress, and assuming no action, it will expire along with many components of 2017 Tax Cuts and Jobs Act.

Traditional trusts utilize this tax exemption for the benefit of both spouses over their lifetimes and thereafter disburse the funds to their children and grandchildren. Unfortunately, this simply kicks the can down the road to the next generation where the assets are – again – subject to taxes and creditors in the beneficiaries’ estates.

A “Dynasty Trust” created today can capture the existing $28 million exemption so it will always apply to the trust’s assets, along with all of its future growth, and provide for multiple generations of Scotty and Caroline’s children, grandchildren, and even great great-grandchildren, regardless of future political climates. 

In Alaska, Idaho, New Jersey, Pennsylvania, Kentucky, Rhode Island, and South Dakota, the common law ”Rule Against Perpetuities” has been modified such that a Dynasty Trust can exist perpetually without ever being included in the beneficiary’s estate.

State Taxes

Closer to home for Scotty and Caroline lies the infamous web of New York state taxes (state income tax of 4%-10.9%, a city income tax of 3.078%-3.876%, a sales tax of 4% 8.875%, a property tax of about 1.64%, and a gas tax of about 25.68 cents). For half a century, NY even claimed tax authority over non-residents who had relocated to other states. (A lingering element of British common law that survived until only 25 years ago.) Scotty and Caroline’s legacy bequests include living expenses, college funds, and a very structured devise of purposeful stewardship for children and grandchildren. Income taxes, especially on an estate, are a dollar-for-dollar deterioration of these noble intentions.  A Dynasty Trust created in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming can avoiding the continued deterioration of New York taxes. There are also eight jurisdictions that do not impose their own state income tax on non-resident grantors and beneficiaries of Dynasty Trusts: Connecticut, Delaware, Georgia, Illinois, New Hampshire, Ohio, Tennessee and Wisconsin. 

Stewardship

Well-informed consumers recognize the impact that money can have on their children and grandchildren, even as they become adults. Though Scotty and Caroline have no desire to “control from the grave”, they have both engaged in a lifetime of community stewardship and fully intend to endow successive generations with similar values and priorities. A Dynasty Trust can be fully customized to govern distributions in accordance with Scotty and Caroline’s specified purposes. It can condition distributions upon a beneficiary’s charitable endeavors or services, it can incentivize certain behaviors or educational achievements, and/or it can provide funds upon the Trustee’s discretion based upon the circumstances of the beneficiaries. Nevada, South Dakota, Delaware, Alaska and Wyoming are generally recognized among states with the most favorable flexibility in its laws and regulations. 

Wealth Preservation 

“Squander” is a rather pejorative reference to an unwise and rapid loss of windfall funds; commonly associated with lottery winners and trust fund spendthrifts. And even while the financial integrity of Scotty and Caroline’s heirs is not directly in doubt, it’s the rest of the world they should wisely question; the proverbial distant relative who suddenly appears seeking a “loan”, the opportunistic fortune hunters, the unscrupulously frivolous litigants, and unfortunately the surprise divorcee. A Dynasty Trust offers legal protections against these evils. When trust beneficiaries only receive funds at the discretion of the trustee, as Scotty and Caroline provide in the document, the assets are protected from frivolous litigation, divorcing spouses and even legitimate creditors of the beneficiary. Nevada, Ohio and South Dakota have recently exhibited a solid history of protecting trust assets.

Flexibility
Dynasty Trusts are most often “irrevocable”. Today, however, that does not mean it can’t be changed. A legal process called "decanting" allows a trustee, acting in Scotty and Caroline’s interests and intentions, to move assets from an existing irrevocable Dynasty Trust to a new one with modified terms, essentially enabling future changes to the original trust without technically revoking it. While Alabama, California and Georgia have adopted a Uniform Trust Decanting Act, more flexible decanting provisions and trust modification options may exist in Nevada, South Dakota, Delaware, Alaska and Wyoming.

The Devil is In the Details

This is not an off-the-shelf trust. It requires advanced legal expertise, time and of course a bit of money. 

The first Devil is in selecting the state jurisdiction that best accommodates Scotty and Caroline’s objectives. In my own professional experience, I’ve helped clients establish such domestic trusts when their specific priorities were best supported by the laws of Florida, Delaware, Alaska, and South Dakota; and other clients whose deeper objectives required a foreign, non-US (offshore) jurisdiction. 

The second Devil is satisfying the various legal requirements for crafting a trust in their chosen state with the proper Trustee situs and asset nexus requirements that eliminate any possible ties back to their home state of New York.

The third Devil is the Corporate Trustee, which should be categorically avoided. Scotty and Caroline should consider a qualified Independent Trustee or Independent Trust company who won’t charge excessive fees, stray from their stated directives, or attempt to rationalize the conflict of interest that accompanies serving as both Trustee and investment manager.

It’s my opinion that the perfect storm exists today for Scotty and Caroline to successfully avoid taxes, protect their wealth, and achieve their stewardship objectives for many generations beyond them.

Author:
Mike Koenig, Founding Partner of FirsTrust, LLC, candidly and unapologetically shares his 36 years of experience as a financial advisor to advocate truth and transparency for financial service consumers. His education and experience includes a bachelor’s degree in psychology from the University of Maryland, a master’s certificate in finance from George Washington University, a Juris Master of Law degree from Florida State University College of Law, and the CFP® Certified Financial Planner™ professional designation