An excerpt from Jeanne Vatterott-Gale’s Chapter in Wealth Counsel Estate Planning Strategy Book: Multi-Jurisdictional Considerations (2021)
By Jeanne Vatterott-Gale (Yuma, Arizona)
Snowbirds with residences in more than one state or retirees who are considering changing their residency to another state must plan carefully. The law of the state in which you reside generally guides the terms of your trust or will, but other factors should also be considered in your decision-making: your income tax liability, state estate tax or inheritance tax liability, and certain provisions affecting beneficiaries.
Trusts, Residency, and Taxation
Much of estate planning is driven by the desire to avoid federal estate tax, state estate or inheritance tax, and income taxes. States may impose estate, inheritance, income, sales, and property taxes.
Generally, the location of a trust’s administration will determine which state tax rates apply to trust income. Often, there is no restriction on a trustee’s ability to change the location of the trust’s administration. However, a change in the trustee’s residency or the trust’s administration may affect the tax rates applicable to the trust. In the event of litigation, it could also affect the court’s jurisdiction and even certain procedural matters, regardless of statements in the trust as to governing law. It is important to be aware of these issues and to build flexibility into your trust documents to enable you and your successor trustee to address them if they arise in the future.
Trusts can hold property located in more than one state. When you own real property, such as residences, in more than one state, a revocable trust is usually the preferred method of ownership because it avoids probate. This is especially important if you have homes or other real property in more than one state not held with rights of survivorship; holding them in a revocable trust will avoid probate proceedings in each state.
State laws vary considerably regarding the best practice for holding title to your personal residence. In Arizona, for instance, holding a primary residence in a trust may prevent the homeowner from qualifying for the state’s long-term care program. Therefore, many Arizona estate planners advise clients to hold their residence in their own names and prepare a beneficiary deed that transfers it to their trust upon their death. Further, be aware that in certain jurisdictions adverse property tax consequences may result when you change your primary residence. In California, for instance, if you cease using your California home as your primary residence, your family, which might otherwise be eligible to prevent increased property taxes upon your death, will lose that ability. Further, be sure to compare the relative tax liability on the sale of your residence if you change residences. The homeowner’s exemption from capital gains taxes cannot be used against a home that is not your primary residence.
An inheritance tax is based on the value of a specific bequest (an inherited item). Although a decedent’s estate is responsible for paying the estate tax, the beneficiary is liable for the inheritance tax. Among the states that impose inheritance taxes, most exempt immediate family members such as spouses and the deceased’s children. Inheritance taxes are applicable in Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
States with no income tax typically attract retirees. As of 2021, Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose income taxes. A lack of income tax does not mean that there are no investment taxes assessed on trust income for irrevocable trusts, inheritance taxes, or estate taxes.
An estate tax is based on the overall value of the deceased person’s estate. The state of Washington, for instance, has an estate tax. The amount you can pass tax-free in Washingto is $2.193 million per person in 2021. Thus, if you own a residence in Seattle, where home values have skyrocketed over the past few years, your estate may be liable to the state of Washington even though your primary residence is in Arizona.
Other states do not have sales tax, for instance, Oregon. However, Oregon has one of the highest income tax rates in the country. There are certain taxation privileges that relate to a taxpayer’s residency requirements, which may differ for purposes of voting, income taxes, or estate taxes. California has a very complex system of constitutional amendments that affect a homeowner’s ability to pass on certain property tax savings to their heirs.
Community Property States
Many western states are community property states. They provide couples with greater tax benefits upon the death of the first spouse than do separate property states. If a married couple purchases and holds rental real estate as joint tenants, upon the death of the first spouse, the surviving spouse will receive a step-up in basis (assuming the value of the property has increased) on the one-half of the property inherited. However, if the couple holds the property as community property with rights of survivorship or converts it by deed into community property before transferring it to their revocable trust, the surviving spouse will normally be entitled to a step-up in basis as to the entire community interest on the death of the first spouse. This may provide enormous tax savings for the surviving spouse.
Determining Your Residency
If you are retiring and wish to sell your principal (primary) residence, you are entitled to avoid taxation of certain capital gains under the federal tax code up to certain levels ($250,000 or $500,000 if married filing jointly). You must meet certain eligibility tests relating to the number of years that you have held the residence. There are also partial exclusions of gain in certain situations.
The Internal Revenue Service (IRS) rules state, “An individual has only one main home at a time.” If you own and live in just one home, then it is your main home. If you own or live in more than one home, then a facts and circumstances test is applied to determine which property is your main home. Although the most important factor is where you spend the most time, other
factors listed below are relevant as well. The more of these factors that are true of a home, the more likely it is to be considered your main home. The IRS will consider the following factors:
The address listed on your
- U.S. Postasl Service record
- voter registration card
- federal and state tax returns
- driver’s license or car registration
The home is near
- where you work
- where you bank
- the residence of one of more family members
- recreational clubs or religious organizations of which you are a member.
Special Needs Beneficiaries
In the context of special needs beneficiaries, the beneficiay’s residency should ultimately be the determining favtor of the appropriate trust terms. This is because, with the exception of Medicare and Supplemental Security Income, most public benfit programs are administered by the states. These programs vary significantly by state. Funds that flow from the federal government into the Medicaid program then flow through the states. Therefore, eligibility requirements for those benefits are set out in state las. Mechanisms should be built into a special needs trust to transfer the trust into another eligible trust if the location of a special needs beneficiary changes.
In view of these considerations, you should have your estate plan reviewed by a qualified attorney admitted to practice in the state of your residency and wherever you own property or administer a trust.
Jeanne Vatterott-Gale is an estate and trust law specialist certified by the Arizona Board of Legal Specialization and a partner in Hunt & Gale, whose attorneys are also admitted in Alaska, California, Colorado, Missouri, Oregon, Texas, Washington, and Wyoming