Trust Law – Comparison between Nevada and California
As may not always be apparent, I am a student of the University of Nevada, Reno’s masters of accountancy program. As such, I’ve got a love for numbers and accounting law. One of the courses that I took last semester was the Gift and Estate Tax class and for our term paper I picked the topic of differences in Nevada and California’s trust law. I’ve heard it repeated that Nevada is more favorable tax-wise than California, and while it’s obviously true for income tax, is it true for estate and trust as well? Here is my paper of my research for the differences for the estate and trust tax laws between Nevada and California.
Nevada is often cited as one of the best tax law states, especially in regards to business and income tax laws. In addition, trust law in Nevada is supposed to be more favorable for those that create trusts within Nevada than many other states. Is trust law truly better in Nevada, particularly in comparison to California which is often thought of as a high-tax state? And what parts are different and how is it better in Nevada if it is?
While conducting research, several main areas of trust law surfaced as not only different, but often more favorable, in Nevada in comparison to California. Homesteading laws, while present in both states, have varying levels of protection for those that file for it. Another area of trust law that both states offer additional protection beyond what is federally guaranteed is the length of life of a trust, though again, Nevada offers a longer, and therefore more protective, lifespan for trusts.
Some of the larger differences, and where Nevada trust law really starts to shine, include the not common trust formation in Nevada called Asset Protection Trusts. And a final benefit offered in Nevada is that there is no trust income tax at the state level, unlike in California which can tax up to 12.3% of a trust’s income. Both states have no estate or inheritance tax unlike some other states in the nation.
Homesteading laws are used to protect a taxpayer’s or trust’s primary residence from creditors up to a certain level. This is an important and quite easy way to protect what is often the most expensive asset a taxpayer or trust may own.
California offers a homesteading law (California Code § 704) that protects varying amounts depending on the tax filing status. The law protect $75,000 for individuals, $100,000 for married couples and $175,000 for seniors over 65 years old.
Nevada also offers homesteading laws (Nevada Revised Statutes [NRS] Chapter § 115) but the law protects more of the primary residence for those that file the paperwork in the state. Nevada protects up to $550,000 of the value of the primary residence.
So while both states offer homesteading laws to protect some of the value that taxpayers and trusts accumulate in their primary residence, Nevada offers more protection and does not qualify it by filing nor legal status. Also, looking at median home values in Nevada and California, $191,700 and $432,800 respectively according to recent Zillow numbers; it is apparent that Nevada’s homesteading law protects more homes in the state than California’s could protect.
Both states offer an expanded lifespan for trusts than is defined by the federal law. These longer lifespans offer a way for trusts to evade the generation skipping transfer taxes which are created to tax trusts at each generation.
California allows trusts a lifespan of up to 90 years according to California Code, Division § 9. This is longer than what the Internal Revenue Service recognizes for generation skipping transfer taxes, which provides for possible benefits for an individual looking to pass on wealth to grandchildren or great-grandchildren.
Nevada is called a dynasty trust state and allows the trust to exist for up to 365 years according to NRS § 111.1031(1)(b). This is one of the longer dynasty trust laws in the nation. However, there are several states that offer perpetual trusts (some of which have a 1,000 year cut-off which is almost half of the life of our nation). 365 years allows for wealthy families to create income for several generations.
While both states offer lifespans of trusts that are designed to evade the generation skipping transfer tax, Nevada’s dynasty trust law is clearly more favorable for those setting up a long-term trust. The California law seems to protect for longer than three generations (if an average generation is 25-30 years) while the Nevada law can protect assets for 12 or more generations.
Asset Protection Trust
Nevada is one of the handful of states that has asset protection trusts. Alaska was the first state to create the asset protection trust in 1997, and Nevada followed shortly afterward in 1999. California does not have a structure in their trust laws for an asset protection trust.
Asset protection trusts allow for the grantor to self-settle, or receive their own assets from the trust. This allows grantors the ability to protect assets from creditors much like an irrevocable trust. In other states that have these trusts, often the time between assets being put into the trust and being protected are longer than the two year window that Nevada allows. Another benefit to Nevada is that once the asset passes that two year window, it is protected from all creditors. Other states have some protection but also allow certain creditors to get at the assets such as spouses (in cases of divorce), alimony and child support.
According to NRS § 166, these trusts are much like irrevocable trusts except for the fact that the grantor can also be the beneficiary. This allows for a different level of protection of assets for high-wealth individuals especially those that are at risk for litigation.
Trust Income Tax
This area is definitely in favor of setting up a trust in Nevada. Nevada has no income tax and this also applies to income generated in estates and trusts. Often an estate can take a while to settle and distribute, so with no income tax, the estate’s trust will not lose value by paying taxes before disbursement. And if the trust is an ongoing entity, there will be no taxes for the estate during its lifetime. California, however, progressively taxes trust income up to 12.3% depending on income earned.
Both states do not tax the estate or estate’s trust when the grantor deceases. However, California somewhat recently eliminated their tax. The phase-out began in 2001 and was completely eliminated beginning January 1, 2005. Though this will no longer effect decisions as to where to form a trust, it would have been important just a bit over a decade ago in the decision-making process.
Neither state has charged an inheritance tax, though there are several states that do and Kentucky even charges both an estate and inheritance tax.
There are several different areas that Nevada and California differ in trust law. Some seem more significant than others. For instance, the protection of an individual’s or trust’s primary residence in Nevada are far better than the protection offered in California, not just in dollar amounts, but also how far the protection goes to help in their respective markets. Especially as for most individuals, and potentially for trusts as well, the home is likely the largest asset. And for some families, the home is likely to be a sentimental asset as well which would be an additional difficulty for grieving families.
From various articles and listings, Nevada is regularly in the top best five states in the nation to form a trust. Nevada and California have some parts of their trust law that are similar, however, there exist some large differences between the two states. Nevada is clearly better in homestead protection, legal lifespan of the trust, asset protection trusts and that Nevada has no income tax for trusts unlike California. For some individuals, California’s laws may prove sufficient, but those that are wealthier or have more complex financial situations Nevada is the better choice. And if one has the choice, Nevada may be a better choice in general.