Income Tax Planning for High Income Tax States
“I think that people in my situation should be paying more tax.” Warren Buffett, to whom that statement is attributed, may be the only person on earth raising his hand to pay more taxes. I suspect even he wasn’t actually volunteering. The fact is most everyone will take a tax break if they can find one.
One place to look for tax savings is by leveraging different state income tax rates. Put another way, as long as there are states with rates lower than yours, there may be an opportunity to lower your income tax. It’s no news that some people up and move to a lower-tax state. But if you like where you are, you may still be able to lower your taxes with some advanced planning.
There are states that say, “If you are the creator of a trust that is administered here, but you live somewhere else, your trust does not have to pay income tax.” The author of this article has extensive experience drafting in Delaware, Nevada, and New Hampshire, all states that offer these tax savings opportunities, but there are other states as well.
By creating what is known as an irrevocable, Incomplete-gift, Non-Grantor trust (or “ING”), you can cause the income to be taxed, if at all, in the state where the trust is administered. An ING trust administered in Nevada (a “NING”), Delaware (a “DING”), or New Hampshire (an “N-HING”) will avoid state income tax. (Avoid administering the trust in your home state, because that will defeat the purpose.)
Suppose you live in Massachusetts or New York and have a taxable, long-term capital gain of $400,000 and interest income of $150,000 in 2021. That would put you in at least the 35% federal tax bracket for married filing jointly, and the 5% or 6.9% bracket in those states, respectively. The taxes would equate to an individual tax liability of $27,500 and $37,675.
Place those same assets in an N-HING and the trust will be thrust 2% higher to the 37% tax bracket due to federal trust tax laws, if you were not there already, but the trust does not have to pay your home-state income tax. The Massachusetts resident trust would save $28,050 and the New Yorker would save $37,675. Hopefully, year after year earnings would rise due to less tax shrinkage, and tax savings would compound. Over 5 years the compounded savings at 7% per year would result in $173,000 in additional earnings for the Massachusetts resident and $270,000 for the New York resident.
For the right candidate, an out-of-state, non-grantor trust that avoids state taxation can be very helpful. To learn more about your state’s income tax rates, check out this Motley Fool page.
How do you know whether you are a candidate for ING Trust leverage? One way to tell is if you are in the highest income tax bracket in your state and you do not need the trust income to be paid to you. If so, chances are you can benefit from the ING Trust. Another may be that you are about to experience a major capital gain, or possibly, the sale of a business, which may provide an opportunity if structured right.
Short of that, one has to run the numbers. If you’d like to do that, feel free to schedule a complimentary consult with Paula Nolan, Managing Paralegal.
