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Residency effect of trusts

On Behalf of | Oct 15, 2013 | Asset Protection |

In the last two decades, the number of trusts that have been executed has grown, perhaps owing to more people becoming aware of their benefits. New Jersey residents may utilize trusts as an asset protection tool or use them to save on federal estate taxes and to avoid the expensive and public process of probate. Although trusts have multiple benefits, using them requires a more complete knowledge of how they work.

A trust is a standalone entity that provides for the ownership of the assets that are transferred into it. Beneficiaries of simple trusts have the responsibility of reporting the income earned by the trust on federal and state income tax returns. If trusts are not accompanied by the necessary tax returns, they can incur serious penalties. It is also important to determine if a trust is classified as a resident or nonresident one. Resident trusts are taxed on income that beneficiaries do not report, and nonresident trusts are only taxed on undistributed income associated with a particular state. States look at the grantor’s state of residence as well as the location of the trustee, beneficiary and assets to determine this classification.

These factors are subject to change after the trust is established. For example, if a state does not have favorable laws regarding taxes on trusts, a person may be able to change the residency of the trust by changing one of these factors, like the location of the assets. New Jersey determines a trust’s residency status when it becomes irrevocable. The state tax law prohibits a resident trust’s income from being taxed if the trustees and assets of the trust are not located in the state.

A New Jersey estate planning lawyer may be able to help individuals who are considering establishing a trust with weighing the benefits and potential tax implications of each kind of trust. The lawyer may also assist with drafting other key documents, such as advanced care directives or living wills.

Source: Huffington Post, “State Taxation of Trusts“, David Seiden, October 07, 2013