By Steven J. Oshins, Esq., AEP® (Distinguished) - Special guest author
Most estate planners automatically situs — which is Latin for position or site — their clients' irrevocable trusts in the jurisdiction in which the client resides without considering the possibility of using a different jurisdiction. This is often done for no reason other than the fact that it is customary to do so. However, in many situations, this decision causes a loss of potential benefits that may have been obtained by exploring the use of a different trust situs.
Common reasons to situs a trust in a different jurisdiction
STATE INCOME TAX SAVINGS. There is almost never a good reason to maintain a non-grantor irrevocable trust in a jurisdiction that has a state income tax on trusts. Such trusts should almost always be moved to a state that has no fiduciary state income tax on undistributed income. This is especially important when a lot of the trust income will not be distributed to the beneficiaries either because the beneficiaries are in a high income tax bracket, where the beneficiaries should not receive large distributions, and/or the beneficiaries have creditor issues and therefore should not receive large distributions for that reason.
Different states tax trusts based on different factors. Some states tax the trust based solely on the residency of the settlor or testator. Other states tax a trust based solely on the residency of a trustee or on the place of administration. Other states tax a trust based on the residency of a beneficiary, although this has been held to be unconstitutional in at least one case involving a fully discretionary trust. Other states tax a trust based on two or more factors. Therefore, it is necessary for the advisors to be aware of the residency of the parties to a trust in order to do the planning.
CREDITOR PROTECTION. Many trusts are drafted to give the trustee the power to make distributions to the beneficiaries for their health, education, maintenance and support. These trusts are often called "support trusts" for creditor purposes. Depending upon state statutes and case law, support trusts are often available to certain classes of creditors, most notably including divorcing spouses. A discretionary trust, on the other hand, gives the trustee absolute discretion over distributions and thus generally protects the assets from a broader range of creditors. (An exception is the 2013 Florida case, Berlinger v. Casselberry, where the Court ruled that even a discretionary trust domiciled in Florida is subject to a writ of garnishment for unpaid alimony.) However, when the trust has been drafted as a support trust, it is imperative that the trust be domiciled in a state that protects the trust assets from various exception creditors.
DECANTING. Currently, more than half of jurisdictions have decanting statutes. A decanting statute may allow the distribution trustee to distribute the trust assets into a different trust with different provisions for one or more of the beneficiaries of the prior trust. This flexibility can become very important when there is a drafting error, a change of circumstances, or an enhancement that the family would like built into the trust. The failure to consider using one of these jurisdictions (or at least allowing the trustee or trust protector to move the trust to a favorable decanting jurisdiction) could mean that the desired changes cannot be made. (Note that trust modification strategies other than decanting might also be an option in some circumstances).
Although decanting has traditionally been used more to fix drafting errors, the sophisticated estate planner will also decant a trust in order to save taxes and/or to protect assets from creditors and divorcing spouses.
DOMESTIC ASSET PROTECTION TRUSTS. Domestic asset protection trusts have become one of the most popular and widely used asset protection techniques. Only a handful of jurisdictions have favorable statutes allowing the settlor to set up a domestic asset protection trust. Although many attorneys are taking advantage of this, many others are not. Some have failed to use this technique because of the uncertainty about whether it will work. This is often based upon a misunderstanding about the objectives of an asset protection structure. The goal is to put the client into a better position than the client was in without the structure. Thus, there will not be a 100% success rate, but, this technique may help the client negotiate a favorable settlement or scare the creditor away altogether.
For a resident of a jurisdiction that does not have a domestic asset protection trust statute, the hybrid domestic asset protection trust may be used because it greatly enhances the likelihood that the trust assets will be protected if challenged in court and it should significantly reduce the settlement number in a negotiation.
The hybrid domestic asset protection trust is a third-party trust where the settlor isn't a beneficiary but can be added as a beneficiary at a later date through the appointment of a trust protector. There is almost never a reason to actually add the settlor as a beneficiary if designed properly. As long as the settlor isn't added as a beneficiary, the trust is simply a third-party trust, generally protected from a creditor of the settlor.
DYNASTY TRUSTS. Dynasty trusts aren't just estate tax savings vehicles. They also are used to provide asset protection and divorce protection for the beneficiaries for as many generations as applicable state law allows. Just as attorneys should use lifetime trusts to protect assets from estate taxes, creditors, and divorcing spouses for the first generation, the same concepts apply to more remote generations as well.
There is no reason not to protect the assets for grandchildren, great-grandchildren, and other beneficiaries. Thus, it is important for the planners and clients to consider situsing the irrevocable trust in a state with a strong dynasty trust statute.
There are many reasons not to simply use the local state trust laws. Just because nearly every estate planner relies solely on the client's local state laws does not mean that the more advanced estate planner should follow suit. It can cost the client's family a significant amount of money in unnecessary taxes, expose assets to creditors and divorcing spouses that could easily have been avoided, and cause the family to miss opportunities for enhanced flexibility.
Steven J. Oshins, Esq., AEP® (Distinguished),is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 "Elite Estate Planning Attorneys" and the "Top Estate Planning Attorney of 2018" by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018 and 2020.
Using trusts for descendants
can protect inheritances.