By Eric Ratliff
A trust is a simple concept. If you have ever purchased a house, then you have experienced a form of trust called escrow. At closing, it was not merely a request that the escrow agent used the proceeds to buy you a house; the closing agent was legally bound to do so.
With this backdrop, in any trust, there must at least be all of the following:
- 1.) A trustee who “legally owns” the assets it holds for the safekeeping of the beneficiary.
- 2.) A beneficiary which “equitably owns” the assets the trustee holds (i.e., subject to the terms of the trust document, the asset is owed to them).
- 3.) Someone who created the trust, the grantor.
All three of these people may be the same or different, and there may be more people involved. This means that a grantor, trustee and beneficiary are necessary; adding more individuals to this equation may be desired but not required.
However, trusts are most often created for certain tax purposes, and this is where the tax tail can wag the trust dog. Otherwise, a trust document could be a page instead of forty in some cases. For federal purposes, there is a body of law that applies in all states, the Internal Revenue Code. Sometimes there is a change here or there based on state law, such as if a person lives in a separate or community property state. When it comes to state taxes, however, or what is known as “SALT” (state and local tax), many states have viewed this as a business opportunity.
Which states are favorable for trusts in regard to tax?
Tennessee, South Dakota, Nevada, Delaware and other states have designed laws which are favorable for federal tax, asset protection and SALT purposes. These states have a view of the U.S. Constitution which effectively prevents other states from taxing trusts located in their state and these states do not normally tax the trusts to begin with. Some states like New York, New Jersey and California are not necessarily income-tax friendly, but one establishing a trust in those states typically knows the tax consequences and perhaps has a different reason for using that state (such as owning real estate there). Sometimes a trust may have been created in these states many, many years ago and face substantial challenges to leave that state to be administered in another tax-friendly state.
Then there is North Carolina, which had the viewpoint that if someone is in their state has something to do with an out-of-state trust, then why not tax them? Why not tax them, even if they did not receive any money from the out-of-state trust? Although a narrowly-construed opinion, the recent U.S. Supreme Court case of North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust (“Kaestner”) sought to make sense out of these competing viewpoints with the aid of the U.S. Constitution. I apologize for the spoiler now, but North Carolina stands corrected as Kaestner won, and the case will require a reasonable person to review if they are paying too much state tax with their tax and legal advisors.
The ruling in Kaestner held that North Carolina violated the Due Process Clause of the Constitution by taxing a non-resident trust (which the beneficiaries had not established) on income based only upon having a North Carolina resident beneficiary. The case involved a New York trust which had trustee discretion over distributions and which had not made distributions to the North Carolina resident beneficiaries.
These facts distinguish the case from an earlier decision on the state taxation of trusts. The Court had previously ruled in Maguire v. Trefry, 253 U. S. 12, 16–17 (1920) that a tax on trust income distributed to an in-state resident passes muster under the Due Process Clause – as is the case in Tennessee under certain circumstances, which is discussed later. The Court also ruled in Greenough v. Tax Assessors of Newport, 331 U. S. 486, 494 (1947) that a tax based on a trustee’s in-state residence is allowable. The same was true under Hanson v. Denckla, 357 U. S. 235, 251 (1958) and Curry v. McCanless, 307 U.S. 357, 370 (1939) for a tax based on the site of trust administration.
What does this mean for you, and specifically if you have a trust located in the State of Georgia?
Based on the above, if your trust is “situs,” or administered, in Georgia, then you are increasing the risk that you might be subject to Georgia income tax. You may also not be eligible for a “Kaestner” result in a no-tax state depending on several factors.
Consider the following list of factors, keeping in mind that some may not apply to you:
- 1.) What’s the residence of the person who created the trust?
- 2.) Is the trust a “grantor trust” which taxes the grantor on income?
- 3.) Do you, as a beneficiary, expect to receive distributed income?
- 4.) Is the trust directed? That is, is there a person in the trust document that can make the trustee distribute income? Where does that person live?
- 5.) Is it at the “sole and absolute” discretion of the trustee to distribute income? Or is the trustee required to distribute income to you?
- 6.) Is your trust administered under Georgia law?
- 7.) Is your trustee (or a trustee among co-trustees) in Georgia?
- 8.) Where are the records of the trust kept?
- 9.) Where is your trust asset custodian (that invests the money)?
- 10.) Regarding the assets in your trust, is it a mixture of money, real estate and/or a business located in Georgia? Or just money (marketable securities, cash, etc.)?
- 11.) Does the trustee meet you and/or your advisors to discuss the trust in Georgia or at an out-of-state location?
- 12.) Does the trust require a distribution in the future?
- 13.) Do you not have a trust at all, but would like to find strategies to legally avoid paying potentially unnecessary state-level taxes?
Why a Tennessee corporate trustee could be the answer
Due to geographic proximity to Georgia and the potential lack of state taxation, if the above impacts you, then you might first consider a Tennessee corporate trustee for your trust.
Regarding a corporate versus individual trustee, you should consider the following:
- Do you know and trust an individual from Tennessee?
- Does this individual have property in Georgia or a reason to frequently visit Georgia? Would trust records and meetings potentially occur in Georgia?
- Is there a chance the person might be considered a Georgia resident in the future?
- When the person is unwilling or unable to serve, who or what’s the next choice?
Given the serious concerns of these considerations, a Tennessee corporate trustee is generally recommended.
With regard to income tax, Tennessee does not tax personal income. Tennessee does have a tax on dividends and income, called the Halls Income Tax, but it is not levied against non-resident beneficiaries. Tennessee does have a corporate tax called the Franchise and Excise Tax, but in most cases, a competent tax practitioner can avoid this tax based on the client’s facts, circumstances and specific needs.
Beyond Tennessee’s tax regime, it is important to note the level of detail necessary to accomplish the Kaestner result. It is not “set and forget.” The Kaestner Court opined on interactions of the trustee and beneficiary of the trust. To achieve Kaestner results, you should periodically, during the year, interact directly with your Trustee, but not in your state of residence, and this is for reasons beyond Kaestner. This means that you will have to visit your out-of-state trustee in a state that is not Georgia. The preeminent choices for this would be Tennessee, South Dakota, Nevada and Delaware. Therefore, your options would be a half-day trip to Chattanooga versus a much longer trip to South Dakota, Delaware or Nevada. The trustee selection should be one of convenience rather than entertainment because you never know how often you will need to meet with the trustee.
The bottom line
In summary, Kaestner is perhaps not as broad as commentators had hoped, but it does provide benefit to certain of those that meet the narrowly-tailored fact pattern it presents. It is possible to design a trust to have the Kaestner effect regarding Georgia tax; however, one considering it needs to carefully weigh the cost of professional advisors, a corporate trustee and if the return on investment is acceptable. One should also not focus on Kaestner for its state tax advantages alone, but instead should view the matter in a comprehensive estate planning context. If you have any questions, contact your trust and estate advisor or reach out to us here.