Mitigating the Impact of State Income Taxes

Using New Hampshire Trusts to Mitigate the Impact of State Income Taxes

In addition to federal income tax imposed on trusts, the rules for state income taxation are quite varied and can reach as high at 10%. Establishing a trust in a jurisdiction that permits a trust to grow without payment of a fiduciary income tax can provide a significant economic advantage to the trust’s beneficiaries. With no state fiduciary income tax, New Hampshire relieves the burden of state income tax and allows trusts to grow far more significantly than other jurisdictions without such favorable tax treatment.

State Income Tax Savings Example 1:

Assumptions:

Settlor gifts $5 million to a trust, which is invested for growth and produces 6% annual rate of return:

  • 2% of the return is considered ordinary income, which is taxed at 40%
  • 2% of the return in considered capital gains and is taxed at 23.8% (20% plus Medicare Surtax of 3.8%)
  • 2% of the return is considered growth and will not be taxed until the gain is realized
  • The blended federal income tax rate of the total return is 22.4%

New York income tax rate is 12.7% (including NYC income tax)

The following table illustrates the trust value after 20 years when federal and state income taxes are paid within different trust jurisdiction:

New Hampshire Trust New York Trust
Year 5 $6,277,557 $6,126,673
Year 10 $7,881,544 $7,507,224
Year 15 $9,895,369 $9,198,860
Year 20 $12,423,748 $11,271,681

State Income Tax Savings Example 2:

The following table illustrates the potential tax savings of selling a long-term appreciated asset with zero-basis inside a New Hampshire trust versus a trust held in New York:

Sale in New Hampshire Trust Sale in New York Trust
Sales Proceeds $5,000,000 $5,000,000
Tax Cost $0 $0
Gain on Sale $5,000,000 $5,000,000
Federal Tax $1,190,000 $1,190,000
State Tax $0 $635,000
Net Proceeds After Tax $3,810,000 $3,175,000
New Hampshire Benefit $635,000 –

TRUSTS WITH INDIVIDUAL TRUSTEES
Some states treat a trust that had a co-trustee residing within the state as a resident trust for income tax purposes and impose their income tax rules accordingly. For example, if a trust is created in New Hampshire naming a New Hampshire trustee and a settlor’s child who lives in New York as co-trustees, then New York will treat that trust as a resident trust and tax the trust income. Therefore, while it may be appealing to name a family member as a co-trustee to provide guidance or oversight, it’s important to understand the trust taxation rules of the state of that individual’s residence. In this case, a directed trust that names trust advisors not serving in a fiduciary capacity, might help the trust assets escape state taxation based on the resident of its individual advisors, while still allowing those individuals to serve among the trust’s decision makers.

HOW PERSPECTA CAN HELP
Perspecta helps clients set up new trusts in and move existing trusts to New Hampshire for a myriad of reasons- including some very important tax considerations. Contact us to see how we can help structure a trust that takes advantage of New Hampshire’s most favorable tax landscape.

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