Advantages of Delaware Trusts
The State of Delaware, known for its innovative trust laws and substantial legal and tax benefits, remains an attractive jurisdiction for residents and nonresidents alike who may be considering establishing a trust. Highlighted below are just a few of these advantages:
State income tax savings:
State income taxes can be a significant drag on the growth of an irrevocable trust. Delaware offers an appealing alternative venue for irrevocable trusts because it does not impose any state income tax on income accumulated for distribution to nonresident beneficiaries in future years. In many states, a trust’s realized capital gains and accumulated ordinary income are taxed at rates between five and 10 percent, with rates in California as high as 13.3 percent. Thus, in addition to the 20 percent rate on capital gains at the federal level, plus the potential net investment income tax of 3.8 percent, state income taxes can greatly reduce trust earnings.
Tax-efficient wealth transfer:
Unlike many states that limit the duration of a trust, Delaware does not place time limits on properly structured dynasty (or perpetual) trusts. Assets transferred into a dynasty trust can benefit generations of clients’ descendants potentially without incurring gift, estate or generation-skipping transfer taxes. See discussion below titled Favorable Tax Treatment for Long-Term Trusts.
Environmental, Social and Governance (ESG) investing:
A Delaware statute recognizes the growing interest by beneficiaries in investing trust assets in holdings that promote ESG goals. The statute allows fiduciaries to take into account “the financial needs of the beneficiaries as well as the beneficiaries’ personal values, including the beneficiaries’ desire to engage in sustainable investing strategies that align with the beneficiaries’ social, environmental, governance or other values or beliefs of the beneficiaries.”
Electronic Execution of Documents:
Under this statute enacted in 2021, inter vivos trust agreements as well as most other documents related to an inter vivos trust agreement can be executed electronically in accordance with Delaware’s Uniform Electronic Transactions Act (UETA). The documents covered include just about any type of document that will be involved in any of the following: the execution of an inter vivos trust; the modiﬁcation of a trust through modiﬁcation agreement, merger or decanting; any release agreements; any resignation, removal, appointment, or acceptance of appointment of a trustee, advisor, designated representative, or protector; and more.
For a variety of reasons, grantors may not want to inform their trust beneficiaries that a trust exists or the nature of their interests in it. Delaware law permits trustees to withhold information about the trust from beneficiaries for a period of time dictated by the trust instrument. Unlike some other states, Delaware does not require a trustee to file trust agreements in court or register trusts with a public agency.
Favorable Tax Treatment for Long-Term Trusts
A client’s ability to contribute assets to a trust that will continue for successive generations without the imposition of any transfer tax, and potentially no state income tax, is an extraordinary opportunity when compared to the alternative of passing assets outright, from generation to generation, subject to a federal transfer tax at each generation. Assuming a $12.92 million contribution to a trust, a 5% after-tax rate of return on the investment assets, a new generation every 25 years, and a federal estate tax of 40% applied at each generational transfer, a Delaware GST-exempt trust would have a value of $501,718,302 million after only 75 years. The same sum of $12.92 million held outside of a trust (and subject to a gift tax or estate tax upon transmittal to each successive generation) would have a value of $108,371,153 million.
Federal estate tax rate: 40%
Return on investment assets: 5% annually
No state income taxes
No distributions from trust or consumption of principal or income
No basic exclusion amount used to offset taxable amount in future years
Careful Planning and Avoiding Tax Traps
While Delaware trusts offer many strategic planning benefits — particularly if drafted with supportive modern trust provisions — taking advantage of them requires careful planning and collaboration among clients’ tax, legal and wealth advisors. For example, a trust can take advantage of Delaware’s deduction for trust income accumulated for nonresident beneficiaries but may still be subject to income tax by another state. A number of factors can cause a Delaware trust to become subject to state income tax in another state. For instance:
Many jurisdictions will treat a trust as a resident trust, and subject to state income tax, if the trust has a fiduciary residing in that state, or if the trust administration occurs in that state. For example, if a Delaware trust has an individual co-trustee or investment or distribution advisor located in California, that state would consider the trust to be subject to its tax regime.
If a Delaware trust has source income from an operating business or real estate located in another state, that state likely will claim that it is entitled to tax at least a proportionate share, if not all, of the trust’s federal taxable income.
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Freedom of Disposition
Methods for Modifying a Trust in Delaware
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