With New Jersey and New York being two of the higher income tax states (New Jersey’s top marginal rate is 10.75% and New York City residents face a top combined rate approaching 13%), an easy recommendation is for clients to go south.
A non-grantor trust is deemed a separate income tax entity—the trust pays its own income tax on income it earns and retains from the assets it owns in any year. Thus, income earned on assets owned by the non-grantor trust, while subject to federal income tax, may avoid state income taxation on its income. The client must retain a certain level of control over the trust to maintain access and to avoid transfers to the trust being treated as taxable gifts (thereby avoiding federal gift taxation).
And therein lies the conflict—the client must relinquish enough control under the federal income tax law to qualify the trust as a separate income tax entity (i.e., a non-grantor trust), yet retain enough control so that the transfer to it is not deemed a taxable gift for federal gift tax purposes. Alaska, Nevada, South Dakota and Delaware are frequently used, primarily because these states have also promoted a corporate trustee business climate that allows residents from states such as New Jersey to easily establish trusts under their laws and thus obtain the income tax-free (and other) benefits of those states.
Many states with high income tax rates have tax law structures that allow their residents to circumvent state income tax by using INGs. In fact, in Tax Topic Bulletin GIT-12, Estate and Trusts, Understanding Income Tax, the New Jersey Division of Taxation has implied that a non-grantor trust created by a New Jersey resident (regardless of the state under which the trust is created) could be subject to New Jersey tax on all its income simply by having just one dollar of New Jersey source income.
References:
Vitiello, A. (2020, March 27). Move to Florida! But if You Can’t, Use Non-Grantor Trusts to Avoid State Income Tax. Retrieved August 27, 2020, from https://www.law.com/njlawjournal/2020/03/27/move-to-florida-but-if-you-cant-use-non-grantor-trusts-to-avoid-state-income-tax/