Trust situs is a complicated topic for many beneficiaries, fiduciaries, and trustees—and with good reason. Generally, situs is a legal term that means the state whose courts have primary jurisdiction over a trust. Loosely defined, trust situs determines which governing tax laws a trust must comply with, generally based on the location in which it legally resides.
Trusts can reside in many jurisdictions simultaneously depending on the location of the trust income producing assets, the location of the trustee, or the location of the beneficiaries. This can lead to tax oversight, legal consequences, and significant challenges. However, when strategically applied, trust situs can provide tax benefits for all parties involved in managing or benefiting from the trust.
For example, there could be situations in which a state situs trust has beneficiaries in other states. The state situs authority could try to tax trust income for the benefit of a state resident. The key is the connections that potentially would cause the state situs authority to tax the trust. There could be several factors that a state might use to establish a connection.
Following is an overview of trust situs and how beneficiaries and fiduciaries can utilize trust situs analysis to simplify asset transfers and reduce taxes.
What is trust situs?
Situs is the state that the trust originated and whose laws will govern the trust. For tax purposes a trust may be taxed in any state for which it is determined to be a resident trust under the governing states definition of residency.
This could be based on the location of the grantor, the location of the trustee or trust administrator, or the location of the beneficiaries. In general, for tax purposes, trust situs is determined by the combined jurisdictions that have the legal authority to tax a trust or trustees.
Beneficiaries and fiduciaries can use situs analysis to locate areas with the fewest or least impactful tax laws and select the best locations for tax benefits or creditor protection.
To whom does trust situs apply?
Trust situs applies to most beneficiaries, fiduciaries, and trustees. A trust can reside in several jurisdictions simultaneously, potentially making it taxable under multiple sets of laws or regulations.
Trusts can also be taxed by multiple jurisdictions in separate states based on where trustees or beneficiaries reside.
If a grantor creates a trust in Nevada, and all the beneficiaries live in that state, the trust will be taxed based on that state laws.
If the beneficiary changes their residence to New York, it doesn’t change the situs of the trust. Many states try to tax trusts that have a situs in another state if the trust was established by one of its residents.
New York is one of these states. Thus New York might claim a trust as a resident even though a resident in another state established the trust.
What makes for a strong situs location?
Where beneficial trust laws exist, trust grantors can provide better wealth transfers to beneficiaries through the trust while reducing taxes. Several factors render certain situs locations more beneficial than others for holding a trust.
- Lack of Conflict. Parties can avoid a conflict of law, conflict of beneficiary upon death, or otherwise.
- Flexibility. Permission to decant or modernize a trust, change the provisions, or move a trust to a different location or situs without consequences.
- Clarity. Clear laws and regulations for establishing, maintaining, and distributing trust amounts.
- Privacy. Established privacy policies that allow beneficiaries to govern how trust sums are managed.
Which laws and requirements should be reviewed when choosing a situs location?
When choosing a situs location to establish or legally relocate a trust, grantors and fiduciaries must evaluate the tax laws of each jurisdiction within a situs as they relate to the different elements of the trust.
Reviewing the following areas can reveal if a given situs allows for greatest possible benefits.
- Timing. Does the state have laws that determine how long a trust may legally exist? If so, it can create significant challenges for beneficiaries. In general, states that have modified their rules to allow trusts in existence for longer periods also make it possible to exempt from gift, estate, and generation-skipping taxes, as well as all trust assets for as long as the trust is permitted to exist.
- Tax requirements. Which taxes does a state impose? This can include multiple taxes, such as inheritance and income. Some states have taxes on insurance premiums, which often come into play with trusts. The least expensive insurance premium tax jurisdiction is generally Delaware, while Nevada could have the highest.
- Legal approach. How do state courts interpret trust laws, and how do financial and legal systems accommodate the trust? Jurisdictions with higher numbers of laws are likely to impose greater taxes. Some states that are generally competitive in the trust arena include Alaska, Delaware, and Nevada. However, some states might need their asset protection laws strengthened.
- Asset protections. Which asset-protection laws exist? These might include a statute that allows investment and distribution decisions to be separate from duties of the administrative trustee.
- Beneficiary rights. How do state laws affect beneficiaries’ rights upon a change in trust situs? For example, sometimes a state’s laws change the provisions of the trust when the trust changes its governing law.
- Trust protector limitations. How does the state recognize the trust protector and the trust protector’s limitations? Fewer limitations typically equate to fewer associated taxes.
What are some additional considerations?
When considering a legal location for trust situs, it’s important to bear in mind that situs laws change continuously.
For example, trustee selection often impact situs. Many states determine situs based on the location of the trustee or the administration of the trust.
When looking at the various factors, careful consideration should be given to the trustee selection and where they’re located and will continue to be located.
Finally, in a June 2019 US Supreme Court (the Court) case, North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust (Kaestner), the Court ruled that a trust beneficiaries’ residence in another state no longer establishes enough of a connection for it to tax the trust. This could create significant tax relief for some trusts.
We’re Here to Help
Beneficiaries and fiduciaries can utilize trust situs analysis to decrease their tax burdens, but selecting the right situs location can be challenging. For more information about trust situs and how to strategically position your trust, contact your Moss Adams professional.