Delaware provides certain tax exemptions for trusts set up by nonresidents. No state can administer a trust for a lower “tax” cost than Delaware. Administration in Delaware can provide a significant tax savings over most states, particularly states with an income tax.
A. Income Taxation
1. Of the trust:
In some states, if an irrevocable trust is managed by a corporate trustee whose principal place of business is in that state—and if the trust is governed by the state’s laws—the trust will be treated as a resident trust for tax purposes.1
As a result, the trustee may be required to pay the state’s income tax on any capital gains or accumulated ordinary income, regardless of where the grantor or beneficiaries reside.2
Delaware provides extremely favorable tax treatment to trusts for nonresident beneficiaries. While the trust is considered a Delaware resident trust for tax reporting purposes, the tax law provides a deduction for income accumulated for nonresidents.3 So long as the beneficiaries reside outside Delaware, no Delaware income tax is imposed on the trust.4
Over the years, some high tax states have tried to impose tax on trusts their residents established in low tax states. Two such cases were litigated, one involving California income tax and the other New York.5 In both cases the courts held that the high tax state could not exercise its taxing powers beyond its borders to tax trusts with a situs in another state.6 This ruling can have significance in assessing the savings from establishing a trust in Delaware, a "no-tax" state as far as a nonresident is concerned.
2. Of the trust’s beneficiaries:
Delaware imposes no tax on income distributed to a nonresident beneficiary.7 Income subject to tax is taxable under the laws of the beneficiary’s state of residence. A trust with all nonresident beneficiaries will pay no Delaware income tax, directly or indirectly.
B. Ad Valorem Taxation
Some states impose an ad valorem tax on personal property, including investment assets.8 Resident trusts pay the tax, regardless of the residence of the grantor or beneficiaries.9 For example, a Pennsylvania trust with beneficiaries living in Delaware pays Pennsylvania personal property tax.10
Delaware doesn’t levy a personal property tax. If the beneficiaries live in states without such a tax, they won’t pay one. If the beneficiaries live in states with a personal property tax, they may be subject to the tax on the part of the trust representing their actuarial interests.11
However, the tax is the personal obligation of each beneficiary and the trust assets are not subject to it. The Delaware trustee is not obliged to collect it.
C. Sales and Use Tax
Many states levy a sales and use tax on the purchase and sale of tangible personal property.12 The tax for resident trusts is usually similar to resident individuals. For example, if a California trust purchases or stores gold bullion within the state, the trustee must pay California a sales or use tax.13 Delaware levies no sales or use tax. If a Delaware resident trust purchases or stores tangible property inside the state, it pays no sales or use tax.
D. Estate Tax
Every state, except Nevada, levies an estate tax. Usually, the tax on estates of deceased nonresidents is levied in proportion to the value of their real and tangible personal property situated within the state.14 For example, if a living trust held gold in Florida, the proportion of the trust invested in gold would be subject to Florida estate tax, regardless of the grantor’s residence.15 Delaware does not levy an estate tax on nonresidents, regardless of where their assets are situated.16
Delaware’s inheritance tax is similar to that of other states in the exemption it provides for a nonresident’s intangible personal property.17 If a nonresident decedent owns tangible property situated within Delaware, the unlimited marital deduction18 and high exemptions for each family member19 render the tax unlikely in most cases.
- See Wisc. States. §71.14(7).
- An irrevocable trust may be taxed in the state of the trustee’s residence, in states such as Arizona, California, Michigan and Virginia.
- 30 Del.C. §1138.
- Mercantile-Safe Deposit & Trust Co. v. Murphy, 15 N.Y. 2d 579, 203 N.E. 2nd 490 (1964) (New York); McCulloch v. Franchise Tax Board (1964) 37 Cal. Rptr. 636, 390 P.2d 412, 61 A.C. 171, appeal dismissed, 85 S.Ct. 278, 379 U.S. 133, 13 L.Ed.2d 333. The McCulloch case states the California position, now codified in West’s Ann. Calif. Rev. & T. Code §17745, that income accumulated from a nonresident trust for the benefit of a California beneficiary will not be taxed during the years of the trust’s administration. The accumulated income will be taxed, however, when it is actually distributed to the beneficiary upon termination of the trust.
- Id. In addition, the due process clause of the Fourteenth Amendment to the U.S. Constitution has been interpreted to require minimum contacts between a taxing state and the person or property being taxed and some benefit or protection must be afforded by the taxing state.
- 30 Del.C. §1122(c); 1142; The income from the trust may be subject to Delaware income taxation if the trust were engaged in a trade or business within Delaware.
- See, for example, N.C. Code §105-274, 275 (North Carolina).
- Commonwealth v. Stewart case, 1940, 12.2d 444, 338 Pa. 9; 72 Pa.C.S.A. §7301,7305.
- Id. In the Stewart case, it was held that Pennsylvania could tax the equitable interest of a Pennsylvania beneficiary to a New York trust.
- See, for example, N.C. Stats. §105-164.4, et. seq.
- West’s Ann. Calif. Rev. & T. Code §6051 (Sales Tax), §6201 (Use Tax).
- This position has been adopted by the Uniform Probate Code and the Uniform Estate Tax Apportionment Act.
- West’s Fla. Stats. Ann. §§198.01, et seq.
- 30 Del.C. §1501.
- 30 Del.C. §1303.
- 30 Del.C. §1323(b).
- As to Class A beneficiaries (husband and wife), the exemption is $70,000, and for Class B beneficiaries (parents, children or other lineal descendants) the exemption is $25,000 for each 30 Del.C. §1322.