John Briscoe, Vice President, Trust and Estate Planning, D.A. Davidson Trust Company
Adrian Snyder, Vice President, Trust Officer, D.A. Davidson Trust Company
You probably selected your state of residency based on several factors, such as where you grew up, proximity to family or friends, climate and/or the location of your job. A factor you may not have taken into account is the financial impact that comes with your decision to reside in a particular state.
Depending on where you live, your tax burden could have a significant effect on personal income. When factoring in property, income and sales/excise taxes, the tax burden looks quite different by state. For instance, New York has the highest tax rate at 12.28% and Alaska has the lowest at 3.71%. For many of us, relocating to a state with a lower tax rate may not be an option, which is why it is useful to understand strategies you can take to minimize taxes, regardless of your state of residency.
There are seven states without a state income tax and two that do not tax wages. All other states impose a tax on income. In addition to the states, there are almost 5,000 local jurisdictions that also charge a tax on income. State income tax is even more important now because the deduction on our federal tax returns is capped at $10,000, if you are even itemizing at all.
If you reside in a state with a state income tax, the use of a non-grantor trust may allow you to avoid state income taxes. A non-grantor trust simply allocates the taxes to the location of the trust rather than that of the grantor or beneficiaries. The key is the use of a trustee that is authorized to accept trusts in a tax free state. For instance, D.A. Davidson Trust Company is a federal savings bank for trust purposes, and since we are federally regulated, we are authorized to accept trusts in any state, including an income tax-free state.
The use of non-grantor trusts should be carefully analyzed by an accountant and attorney to identify any restrictions. These trusts can result in large tax savings, especially when used while planning a sale of a highly appreciated asset.
Revocable Living Trusts
If fully funded, your revocable living trust avoids both probate in your state of residence when you die, and ancillary probate in any other state where you own property.
The term ancillary probate is used to describe probate in a state other than the state of your last residence. For example, if you own a beach house in Oregon in your individual name, but you live and pass away in Washington, ancillary probate will be held in Oregon and probate will be held in Washington.
Ancillary probate means two attorneys (one licensed in each state), two courts and two executors or administrators (one in each state), two sets of fees and, maybe, two different sets of heirs, if state intestacy laws apply. (Intestacy refers to the condition of an estate if someone dies without a will or if the will covers only part of the estate.)
You can avoid probate and ancillary probate with a fully funded revocable living trust. Fully funded means that all of your assets have been funded, or transferred, into the trust. For real estate, you would need to deed the property from your name to your name as trustee of your trust. Assets that commonly cause ancillary probate are time shares, vacation homes, condominiums and any personal property such as home furnishings and cars owned in another state. If you wish to avoid probate and ancillary probate, make sure that your revocable living trust is fully funded and your assets are properly titled.
Limited Liability Companies (LLCs)
LLCs are a flexible business entity, which is great for estate planning. There are many advantages to an LLC, including:
- Asset protection – A creditor can only go after assets owned by the liable LLC. It is a good way to parcel out high risk assets from lower risk assets.
- LLC membership units – These act as shares and easily can be used to divide partial ownership of assets; rather than trying to deed 10% ownership, you simply transfer 10% of the units.
- Useful governance documents – It is not uncommon for disputes to arise among common owners when it comes to costly repairs. LLC documents can provide a framework to resolve disputes more smoothly among multiple owners.
- Favorable valuations – If there is a valid business reason for creating an LLC and transferring units other than just to receive a discount, the courts have upheld discounts of ownership for lack of control or minority ownership. These discounts can directly reduce estate tax. The IRS has held that owning 90% of an asset is worth less than 90% of the asset’s value.
- Conversion of real estate ownership to personal property ownership – This is beneficial in many situations. For example, if an Idaho resident owns an Oregon beach house, owning real estate in Oregon subjects a person to Oregon estate tax on the value of that real property. However, if they deed that property into an Idaho LLC, it is now personal property and no Oregon estate tax is owed.
- Allows transfer of ownership but retention of some management or control – This is great for people who need to gift for estate tax purposes but are not willing to completely turn over their assets. A word of warning, however, the IRS has designated some powers that must be delegated to a third party, such as distributions. That is an ideal opportunity to leverage a corporate trustee.
For many of us, the selection of a state of residence was likely not based on tax impact. D.A. Davidson Trust Company is here to help families identify the most appropriate course of action to minimize your tax burden. Our team of experienced professionals can be reached at (800) 634-5526.
Not FDIC Insured | No Bank Guarantee | May Lose Value
Please read this important statement: D.A. Davidson does not give tax, accounting or legal advice. When creating a financial plan or reviewing an estate plan or trust, D.A. Davidson may provide suggestions or other input with respect to legal or tax related matters. To the extent D.A. Davidson provides any such suggestions or input, clients must seek the advice or services of their legal and tax advisors, and cannot rely on such suggestions or input from D.A. Davidson.