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 as well as a new statute enacted in 2022 on the electronic execution of trust agreements:
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. As an example of the potential tax savings, if two trusts (one in California and one in Delaware) were to sell a zero-basis asset for net proceeds of $5 million, the after-tax proceeds of the sale in the Delaware trust would potentially be worth $665,000 more because the proceeds in the California trust would be subject to California income tax at a rate of 13.3 percent.
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 — a type of generation-skipping trust — can benefit generations of clients’ descendants potentially without incurring gift, estate or generation-skipping transfer taxes.
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 by allowing 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 new statute, trust agreements as well as most other documents related to a trust relationship can now 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 designated 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.
GST-exempt (or Dynasty) Trust’s Economic Benefits
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 $12.06 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 an approximate value of $468 million after only 75 years. The same sum of $12.06 million held outside of a trust (and subject to a gift tax or estate tax upon transmittal to each successive generation) would have an approximate value of $101 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 as long as it avoids a tax nexus with another jurisdiction. 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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Administrative or Directed Trusts
Delaware Incomplete Non-Grantor (DING) Trusts
Freedom of Disposition
Methods for Modifying a Trust in Delaware
Explore solutions to common client situations enabled by Delaware trusts.