May 1, 2006 12:00 PM, By Thomas R. Pulsifer, partner, and Todd A. Flubacher, associate, Morris, Nichols, Arsht & Tunnell L

By: By Thomas R. Pulsifer, partner, and Todd A. Flubacher, associate, Morris, Nichols, Arsht & Tunnell L

Many advisors are not aware that their clients might use Delaware trusts for state income tax planning. Delaware law can enable individuals residing in many states, such as New York, New Jersey, Kentucky, Massachusetts, Michigan and Missouri, to use Delaware trusts to minimize or even avoid state income taxes. That's because there is no Delaware income tax on Delaware trusts benefiting individuals who reside outside of Delaware. In fact, the states we've just listed don't tax a Delaware trust's income if the trust is a non-grantor trust; it's possible for such trusts to be funded with incomplete gifts. However, advisors must resist any temptation to abuse the Delaware trust option. In fact, such trusts ideally should be funded solely with assets that settlors essentially want to hold for the next generation.

In general, Delaware treats as a Delaware resident trust any trust that has at least one trustee located in Delaware.¹ Delaware resident trusts may take an income tax deduction both for the amount of their federal distributable net income that is actually distributed² and for the amount of their federal taxable income that is set aside for future distribution to nonresident beneficiaries.³

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