While many Americans take advantage of states with no income taxes (like Nevada), the placing of financial assets into trusts is gaining scrutiny from officials in other states. For example, individuals who are in the process of selling a company may move shares from that company from one state to out-of-state trusts so that these gains will not be subjected to state income tax treatment.
Nevada officials have long supported such a practice. The concern in part is to allow individuals to pass wealth onto their heirs without concerns that money will be taken away by creditors. Even out-of-state attorneys need to advise clients of this option because it can come down to paying taxes on the funds versus not paying taxes upon the funds.
Each state likely has its own unique set of rules when it comes to the passing on of wealth to heirs. However, as high-tax states may feel that they are losing out when it comes to the setting up of these sorts of trusts, these states may also be looking for ways to limit this kind of practice. The New York Department of Taxation and Finances estimated that one particular proposed law limiting the use of out-of-state trusts could generate for them as much as $150 million per year.
Any tax strategy concerning the use of trusts should first be discussed with an experienced trust administration attorney. Determining what income generated by trusts can be taxed is complex.
So long as the money remains inside of the trust and the person setting up the trust retains a certain amount of ability to decide how the money is spent, it may not be subject to the federal gift tax. However, there are instances where the undistributed income of the trust will be subject to taxes.
Source: Bloomberg Businessweek, “Wealthy N.Y. Residents Escape Tax With Trusts in Nevada,” Richard Rubin, Dec. 18, 2013