Holding assets in trust can be an effective estate planning tool. As a result of the passage of some favorable legislation in recent years, New Hampshire has become an attractive state for trusts to domicile and apply New Hampshire governing law. This is a brief summary of some of the major benefits:
- Trusts can have an indefinite (perpetual) life in NH, so wealth can transfer from generation to generation. This feature can result in substantial estate tax savings.
- Effective January 1, 2013, non-grantor trusts are no longer subject to the NH Interest and Dividends tax (NH I&D). Additionally, nonresident beneficiaries are exempt from NH I&D tax on trust distributions. This is a significant advantage over other states which impose state income tax on income retained in the trust.
- Trusts can be decanted, which means that a new trust may be formed and assets transferred from the old to the new trust. This is helpful when the trustee needs to improve some administrative provision of the trust that has become outdated or ambiguous. However, caution should be taken when a trust owns NH real estate, since a transfer of these assets generally triggers the NH real estate transfer tax.
- Asset Protection Trusts can be created to protect the trust assets from the settlor or the beneficiaries creditors. In most states, creditors typically have the ability to reach the interests of the settlor in a trust, and sometimes they can reach all of the trust property.
As noted above, non-grantor trusts (trusts taxed as a separate entity for federal income tax purposes) are no longer subject to NH I&D taxes at the trust level. As a result, only distributions of interest and dividends from these trusts to NH resident beneficiaries will be subject to the tax. A planning opportunity exists in the case of a simple trust (which requires annual distribution of income to beneficiaries) to decant the assets into a complex trust, in order to allow more flexibility on the timing of distributions.
A NH trust with resident beneficiaries could use a strategy of purposely accumulating interest and dividend income in order to reduce the beneficiaries liability for the NH I&D tax. In the case of high income beneficiaries, who may also be subject to the new net investment income tax which became effective this year, deferral of distributions could provide additional tax savings. However, a careful analysis should be performed since the trust threshold for the net investment income tax and the overall income tax brackets are much lower for trusts than for individuals.
Another tax planning strategy is to transfer shares in a business entity (such as an LLC with transferable shares or S Corporation) to a non-grantor trust. If an individual owns shares in one of these entities and the entity makes a distribution, New Hampshire resident owners may be subject to NH I&D tax on the distribution. If a non-grantor trust receives the distribution, there would be no NH I&D tax because beneficiaries of non-grantor trusts are only taxed on interest or dividends reported and taxed as dividends federally. Since distributions from these types of entities are generally not subject to federal income taxes, this can provide an opportunity for significant tax savings.
In summary, strategic planning can result in tax savings both at the trust and at the beneficiary level. The trustee should work with the beneficiaries’ tax advisor(s), in order to determine the best tax planning strategy for their situation.