The Delaware Income Tax Advantage for Trusts

Sponsored by Wilmington Trust

By Jeffrey C. Wolken

• Recent changes in the federal tax laws have provided a renewed focus on state income taxes and strategies available to minimize these taxes.
• While personal trusts have been used most commonly as estate and gift tax planning vehicles, they now have increased importance as tools for minimizing a family’s federal and state income tax liability.
• If you live in a high-tax state there may be opportunities to reduce or eliminate state taxes on some of your income by establishing a new trust in Delaware or moving an existing trust to the First State.

The Tax Cuts and Jobs Act passed in late 2017 made significant changes to many areas of federal tax law and highlighted the importance of income tax planning. Personal trusts, where individuals establish trusts for their own benefit or the benefit of other individuals, have been used most commonly as estate and gift tax planning vehicles. However, some of the changes under the new federal law have increased the importance of personal trusts as tools for minimizing a family’s federal and state income tax liability. Holding family wealth inside a personal trust may limit the ability of your home state to tax the trust’s income, and provides flexibility in customizing the income tax cost basis step-up upon death. Your family’s asset “location” (where your assets are held in trust) instead of asset “allocation” (how your assets are invested) is now a primary driver of wealth by reducing or eliminating the drag of income taxes. The following strategies may provide opportunities for your family to minimize income taxes by making the First State the home state for your assets.

State income tax minimization using personal trusts

Delaware has a state fiduciary income tax on income accumulated in a non-grantor trust where the trust itself, and not the grantor, is taxed on income earned by the trust. However, there is a full exemption from this tax if the income is accumulated for beneficiaries who are not current Delaware residents. Due to the low population of Delaware and the fact that many trusts coming into Delaware have no other ties to the state, most trusts administered in Delaware are not subject to Delaware income tax. Consequently, using Delaware as a personal trust planning jurisdiction is similar to using states that don’t have any income tax.

As state income taxes become a more significant percentage of your overall tax burden, if you live in a high-tax state there may be opportunities to reduce or eliminate state taxes on some of your income.  Regardless of your state of residence, you may create a new trust in Delaware and most existing irrevocable trusts may be moved into Delaware for ongoing administration. Personal trusts offer many tools to shield certain assets from income taxation in your home state. 

Download a pdf of this article.

Please see important disclosures at the end of the article.

Note that a few states, including Delaware, have special trust advantages that may not be available under the laws of your state of residence, including asset protection trusts and directed trusts.