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- [00:00]
A
Foreign.
- [00:09]
B
What is up? And welcome back, everyone, to another episode of the Practical Planner podcast. I'm your host, Thomas Goldman, and here with me are Dave and Ann. So we got the full team here today to talk about something that I would say is a little bit complex but extremely important for advisors working with any clients that have enough wealth to even think about the irrevocable trust side of things. So, so basically, whole goal of today is to really talk about states that are good places to use irrevocable trust in and why. So, Ann, when, when we bring up this topic, where does your mind first go? Like, what are, what are some of the states? And maybe even before that, like, what are we looking for that makes a state a good place to have irrevocable trust?
- [00:52]
C
Yeah. So you probably have heard that there are certain states, like, you know, I'm just going to throw out some names here, but Nevada, Delaware, Texas, that are pretty good for trusts. And you're probably wondering, is this something that my clients can take advantage of? And why would you want to have a trust situated in one of these states? There are a couple of concepts here to kind of tease out, as it were. The first is that when we're talking about putting a trust in a different state, what we're really talking about is kind of in the irrevocable trust context. So if you have a client who has a revocable trust, so, like just a will substitute, they're probably not gonna be able to choose, like, what state applies to them, because this is a revocable trust. It's themselves, for all intents and purposes, including for income tax purposes, up until they die. And so if you're in the revocable trust world, you know that this is not necessarily a strategy that's, you know, or a concern that's relevant until after your client has passed away. However, I will talk about one thing that you should look for in those revocable trusts. So when you're in the irrevocable trust context, all of a sudden you have a reason to have had that trust. And usually it has to do with income tax planning, estate tax planning, some objective, and perhaps even asset protection. And so for all of those reasons, you might want to situate your trust somewhere other than where your client lives. And so what happens is you have a consideration on the income tax side. You have states that have income taxes, separate income taxes from the federal. And so you want to pick a jurisdiction where ideally that is a zero for any of the income that your trust is producing. And so again, those would be states like Nevada, Texas, Alaska. And then you also have the consideration of asset protection oftentimes. So some states, if your trust is situated, let's say in Alaska, and I think Alaska was actually the first state that had a very robust set of asset protection laws for trusts. What happens is your beneficiary, so let's say this is your client's child might get divorced or get into a situation where they have a creditor come after them. So think an accident of some sort or a tort that, and there's a judgment against that beneficiary. Alaska will say, well, this trust is situated within my borders. I consider this to be an Alaska trust. And so the assets, even though they're for the benefit of this child, cannot be reached by the creditor. And so those are the types of protections that can be more robust in some states than others. And that will be a state specific kind of determination. Then lastly, I have to mention there are some states also that have very friendly rules with respect to how long your trust can last within their borders. And so this would be something called the rule against perpetuities. You do not need to know actually how it works, but just know that what happens is some states, say in about a hundred years. So this would be like my state, California, we expect all the trust assets to come out and not be in the trust anymore. And so those beneficiaries, whoever they are, it's kind of like winning the lotto. You happen to be the beneficiary. In 100 years, that beneficiary gets all the assets in their own names. And so any of those asset protection or tax planning objectives that your client had kind of go away. And now all of a sudden that beneficiary has to take that, those assets and do the planning all over again using their exemption, et cetera, et cetera. And so there are certain states have done away with these kinds of rules and basically make trust last almost forever. I mean, it's like 360 years, 400 years even, honestly forever. And so between those three concerns, so that would be income tax planning at the state level, asset protection planning. So the trust assets are hard to reach by a third party. And also trusts being able to last for pretty much forever, you might have a client who picks a state based on those three features. Dave, have I forgotten anything?
- [05:32]
A
No, I think that was pretty comprehensive.
- [05:34]
B
So how do you end up picking one of those dates? Like, I think for me as an advisor, the way that I think about this is any letter you heard in front of like, in, like Ning Ding, etc. Those are probably some of the best dates. Right. But once you know, those are a few of your options, how do you end up actually putting this in force? If you're an advisor and say, hey, I'm in California, I'm working with the California estate planning attorney, are they going to be able to write documents in the state? Are they just going to connect you to a trust company there and help do the advice? I know that's a big question a lot of advisors have.
- [06:04]
C
Yeah. Dave, do you want to tackle.
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A
Yeah, I think, I think in a lot of circumstances the state, it's going to be six one way, half dozen the other, as far as, because they're all competing with each other to have really attractive laws that generate trust business to the state. And so, you know, in a lot of circumstances, there are going to be some small nuances, but it's really going to be about, you know, what trustee you're looking to choose and, you know, where they're situated. And I think one, one really important thing to understand is that, you know, when you're choosing to have your trust administered in another state, let's say it's for asset protection purposes, and let's say you have a rental property in your home state that has a high income tax, you know, liability associated with the income associated with the property. That's going to be a tough one to move into a trust that' outside of your jurisdiction. Because the judge is going to say, well, that property is physically here. And you're trying to tell me that the state is not allowed to tax any income associated with it. So, you know, there's a lot of nuances to it. I think when, when you're choosing, you got to think of what is my goal? Is it asset protection, is it income tax mitigation? And then look at the nuances between the states. But I think, you know, in that laundry list of states, whether it be Alaska, North Dakota, New Hampshire, Delaware, you know, a lot of them are going to have some really close similarities. So it might just come down to what trust company you're really comfortable with.
- [07:41]
B
So in that, in that situation, though, you were talking about the rental property. So if you did want to put a rental property in your vocable trust in that situation, are you most times going to be like, maybe we have irrevocable trust in a different state for different purposes, but then another irrevocable trust in our state because of that.
- [07:58]
C
So this Is where the choice of law, this is like a whole area of the law is based on the asset that's within the trust. What is the law that really attaches to that asset. And by and large, and you guys may all know this in case you've ever been involved in litigation or things like that, where choice of law also becomes this concept. Think of trust as contracts, just like any contracts you may have negotiated there, like choice of law provisions. So real estate is considered to be this, like, super unique asset for tax purposes, for contract purposes, for litigation. And so usually the choice of law starts with, you know, if this is real estate, then that state's laws will govern. And it very much is because states believe that, you know, real estate, I mean, it's literally physically located in their borders. And it really should not be like, you know, Delaware law imposing itself on, like, something having to do with California, like land, if that makes sense. So real estate is kind of always carved off as a special class. And then the choice of law after that, you might have a lot more control, especially. And this is going back to the last thing that Dave said. If your trustee is located in that state, usually to be able to effectuate picking a state, you have to have your trustee in that state. Then we get into all of the questions of how do you pick a trustee? Hopefully we'll have a guest soon on this podcast who can talk to us a little bit about that concept and especially corporate trustees. But at a minimum, each of these, the choice of law is more effective and more respected by the courts. If your trustee happens to be in that state, there, all of a sudden you are looking at moving your trustee in terms of the attorneys. You know, you asked about the nuts and bolts, Thomas. Your attorneys, usually it depends, right? Some attorneys are very comfortable saying, hey, like, I do this kind of like Delaware Trust all the time, even though I'm located in California. And by the way, that was my practice when I was in private practice. But you always have to have an attorney locally sign off on the documents, look at them, actually kick the tires on them, charge the client some sort of fee, and usually the corporate trustee also has an attorney who's making sure that their local laws are being reflected appropriately. Now, do you need three attorneys to look at a single trust? Maybe not. Because sometimes that corporate trustee's attorney might be able to play that role of making sure that, like, the Delaware law is being reflected correctly in your trust documents. That will depend a little bit on the attorney's preferences, local practice, the ethics rules, for that local state and how aggressive they think the regulator might be. But generally speaking, you will have attorneys in other states who work with your family that you know, the client's family, who can prepare some of these irrevocable trusts. But then at the end of the day, they do have to end up coordinating with somebody local, either the trustee or another attorney, to make sure that the trust is appropriate.
- [11:22]
B
Okay, that makes sense to me. What are like some of the most common times that people are doing this and setting up trusts in different states?
- [11:31]
A
I mean, I think that the two most common are state income taxes and they're trying to mitigate that by putting assets into a jurisdiction that does not have some of the high income tax rates that they currently have, like in California, New York, Massachusetts, some of these states. And it can be potentially an effective way to lower your tax bill. I will say that those states are highly motivated to crack down on those types of tax avoidance methods. So you gotta be really, really careful and make sure that you're crossing your T's, dotting your I's, and that you're following the law to make sure that there truly is a separation and that the state, because those states are really cracking down even statutorily to try to avoid people from avoiding state income taxes in their state. The other thing is people who have high liability risks. There's really, really great opportunities in states where you can have what's called the self settled asset protection trust, where in a lot of places, you know, if you're a beneficiary of a trust, that's going to really hinder you as far as creditor protection because the creditor is going to be able potentially have access to your assets if they were to sue you. But in some of these states, like New Hampshire and South Dakota and some of these other states where you can do south self. What am I trying to say here? Self, self settled asset protection trusts, you can actually be a beneficiary of your own trust and still get the asset protection. So the Uniform Fraudulent Transfer act usually applies to a lot of that. So once you've already incurred a liability, it's usually not going to work to try and stuff it into one of these trusts because it might be able to be undone. But if you are at a high liability risk or you're just looking for a place where you can still have the benefit of assets but still get asset protection from creditors, you might choose one of these states to set up a trust.
- [13:40]
C
Yeah. So the way that I think of it is Kind of a waterfall on the asset protection. It's like the highest kind of like most likely person who will get asset protection from one of these states is going to be a beneficiary who's not also creating the trust. So this would be like dad sets up a trust for kid kids trust is pretty, you know, like they tend to respect that. And then the next step is like, okay, you create a trust for yourself where you want to like have those assets isolated from your creditors. The next highest kind of level would be if you're a resident of that state yourself. If you happen to be in Nevada or in Alaska and you do one of these self settled asset protection trusts, Alaska might be more willing to give you the asset protection. And then the last row is like, okay, you're in California, you're not a resident of that state, but you set up a trust in the other state because you know they have good asset protection rules there. The California courts might just be like, I'm sorry but like you had a hit and run in California and your assets, you know, like it's nice that you set up this trust in Alaska, but we're not going to respect it because you're a resident here in our state. So there's kind of a waterfall of like the possibility of setting up an effective asset protection trust.
- [15:06]
B
That makes sense. And I bet a lot of advisors minds are going to like, how come you guys didn't say for estate tax planning? But the question really was like, why would you consider some of these other states? Like whether you do your state or a different state, it's still going to have the same federal estate tax planning benefit. It's just on the state level. And Dave, I think you're talking a lot here about like some of the states will come after it still. And this is the whole idea of like the nings, the dings, etc. Right. Like it used to be a thing in California that you would set up this trust and you try to basically avoid the state taxes on the capital gain, etc. And they've basically come back, I don't know what the year, what that was like 2021 or something or like, nope, that's not going to fly anymore. You actually are still going to end up paying the state taxes.
- [15:47]
C
Yeah, we can do a whole episode on dings and nings and all those things. But New York also has very similar rules where they shut down basically the ability for a New York resident who's about to face like a big state income tax bill to be able to scroll off assets into a different state and say, like, oh, then these are not subject to New York state tax. So a lot of these states, as Dave was mentioning and as you're mentioning Thomas, have kind of like closed any of those loopholes that were based on kind of like a federal law concept. So they're like, no, no. Like, we tend to track federal law, but for state income tax purposes, we're going to close this loophole. Yeah.
- [16:29]
B
Yeah. I think one other reason that we didn't talk about using some of these other states is for some of, you know, stacking USPS eligibility. Right. So we have clients, other people who, you know, we'll talk about this in a future episode that use trust to stack that 10 million capital gains exclusion. And it used to be a thing like we're talking about here that in California people would be like, I'm going to put this in a different state and help on state taxes. But USPS is not recognized in California, for example. But there are people who use this maximize us and then also avoid the state tax liability in certain areas or just maximize QSPS eligibility in general. They typically still use those same states.
- [17:07]
C
And here maybe to give a couple of ideas to the listeners here, because we always like to have some practical advice on the Practical Planner podcast is, you know, if your client today cannot take advantage of having an irrevocable trust in a state like Alaska, you know, what can you do to make sure that if there was the opportunity, that you've kind of like potentially set them up for that? And so here I'm going to talk about the wills and the revocable trust that your clients have. So they probably or they should have one of these documents in place. And if there's ever the possibility of those documents creating an irrevocable trust. So this would be a marital trust, a trust for a descendant, you know, an education trust, whatever it may be. Make sure that in the boilerplate, there are two features that are going to improve the chances that your client's plan could take advantage of moving their trust into a different state. The first one is just giving the power to the trustee to change the state in the first place. Oftentimes there's a governing law clause that will say, my client is living in here, San Francisco, California, and the governing law is California. But if the trustees want to, they can change the law of the trust. That is called changing the governing law or the situs. Then the second thing is the ability to change your trustee. Remember we said that to have the protections of those laws, your trustee needs to be in that state. Just make sure that the documents have the ability, ability for a beneficiary or somebody to be able to replace, remove the trustee. So that way any revocable trust created under your client's will or revocable trust can be moved.
- [19:12]
B
Have you ever seen it where you cannot move the, the trustee, and that is like potentially the lawyer who helped draft the documents, and you get stuck with that? I've come across recently like a client who inherited an estate and the fees they're paying are absolutely crazy, but they don't have the ability to make the change.
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A
What happens all the time.
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B
It's crazy.
- [19:36]
A
Yeah, I mean, I think, I think that's, that's a huge issue that comes up. I mean, a lot of it comes down to the intent of the grantor who created the trust and whether they wanted their beneficiaries to be flexible. I mean, in my experience, in most circumstances, a trustee doesn't necessarily want to be a trustee. For beneficiaries who don't want them as trustee, it's just an uncomfortable position to be in. But at the same time, you know, it's a business and, you know, they're collecting fees, especially if they have the asset management end of it as well. And so that's why it's really important when you're creating these documents to think about these things and make sure that there's some kind of flexible way to change the trustee. What that process is is going to depend on the grantor's intent, whether they want the beneficiary to have more ability to do that or to vote on it or what the case is. But if you don't build in any flexibility, there could be the chance that you're somewhat stuck. Unless the judge thinks otherwise.
- [20:37]
C
Yeah. So most well drafted estate plans, and maybe it could be intentional, but most flexibly drafted estate plans will have a whole waterfall of people who can remove and replace the trustee. And that's a good thing because you want to avoid what is the ultimate way to change your trustee, which is to go to court and have the court decide which trustee you should have. And for those of our listeners who like to hear about kind of celebrity, celebrities and estate planning in the news right now, Jimmy Buffett is, you know, there are some new source news stories circulating about how his widow is struggling with the trustee that he picked for her marital trust, and so she's having to go to court to remove him.
- [21:27]
B
Interesting. I think this all goes back to like my core philosophy and financial planning is add as much flexibility as you can while still getting the benefits you want when possible. But anything we haven't hit on today in this topic?
- [21:42]
C
No, I think this is, this is one of my favorite topics because we used to have clients move all the time, you know, and their beneficiaries move their clients. Kids move out of California or New York and go to more tax advantaged states. Keep an eye out for the beneficiaries moving to one of these states that we've mentioned because they become ideal trustees. They might change the state income taxation of those trusts simply by moving as well. And so that's just something else for you to keep in mind is the beneficial movements, children changing states. It's actually a really good thing and
- [22:19]
B
a great thing for advisors to be aware of. Right, like your, your client or you're not working the state planning attorney every year. But you can just in the beginning of conversation like oh, your daughter, son moved. Where to? Florida. Oh, well, here's a good tax planning move we could consider that you know, you would never have thought of. It's a really good point. But okay, perfect guys. Well everybody appreciate you listening. Remember, please rate and subscribe.
- [22:44]
C
Subscribe.
- [22:45]
B
Give us five stars and we'll see you back here in a couple weeks for another episode.