Don’t Let The Wrong State Get Between You and Your Assets

Gwyneth Paltrow, the actress who created the successful lifestyle brand Goop, said last summer that she and her new husband, Brad Falchuk, were living apart, on purpose. Although recently married, they had opted to maintain separate homes.

The practice, known as living apart together, dates at least to the 18th century, both among avant-garde artists bucking conformity and working people needing to sacrifice cohabitation for economic necessity.

In a recent interview in Harper’s Bazaar, Ms. Paltrow said they now live under the same roof. But the curiosity generated by her embrace of the practice gave lawyers and wealth advisers an opportunity to point to its risks. If a couple, wealthy or not, live in different legal jurisdictions, there can be a battle over which municipality’s or state’s laws prevail if they decide to divorce.

“The implications on a couple that is married and wants to dissolve the marriage, that’s where you’re seeing the ramifications of this,” said Michael Stutman, a founding partner of the law firm Stutman Stutman & Lichtenstein. He has represented clients in a living apart together arrangement who filed papers in the county or state that would grant them more favorable treatment in a divorce.

Divorce is not the only area where choosing one state over another can make a huge financial difference. For certain financial transactions, people can benefit from a state’s favorable laws without even living there.

It has gotten to the point where some states have begun promoting their ability to offer better protection than their rivals.

The competition has also had a leveling effect; “state shopping” is no longer a tactic of the megarich. Merely affluent people looking for a better financial deal for current or future assets now have multiple, cost-effective options.

But not doing your due diligence can have unintended consequences. “State law makes a difference,” said Michael Roberts, president of Arden Trust Company in Atlanta. “If you have not planned, the state has a plan for you.”

Here are four areas where picking the right state matters as much as choosing the best financial plan.

When couples uncouple

When it comes to divorce, a couple with homes in two states, like California and New York, can face vastly different treatment of marital assets. California is a communal property state, where assets are split in half; New York is what is called an equitable distribution state, meaning there is more latitude in deciding who gets what.

Mr. Stutman recently represented a wealthy husband who was living and working in California while his wife lived in New York. When the marriage dissolved, Mr. Stutman said, he acted quickly to file the divorce papers in New York before the wife’s lawyer could file in California.

“It was a nine-figure pot of money, and the difference between the two states was eight figures,” he said. “It’s a bit of a race to the courthouse.”

The risk of living apart together exists for people in the same state but different counties. Mr. Stutman said a New York couple could file in any county in the state. Suffolk County, which encompasses the wealthy towns that make up the Hamptons, has traditionally been more favorable to the spouse who earned the money, particularly if the couple owned a home there.

Sometimes, the state will make decisions for a couple living apart together. In financial matters, for instance, most states will choose a sibling or a descendant over a partner living in a separate residence, Mr. Roberts said.

“If you’re living apart together and you want this person to be the beneficiary of your estate, then you need to have a will and spell this out,” he said. “If you don’t, it may end up with your brother that you can’t stand.”

Privacy vs. secrecy

States also have different views on being private and keeping secrets. Delaware allows for trusts to be set up so beneficiaries don’t know they exist until an age determined by the person creating the trust.

Other states require that beneficiaries be told of the trust on their 18th or 21st birthday. In Delaware, a person could be kept in the dark until 30 or 40 or later.

“Parents don’t want to tell someone at 18 that they have this multimillion-dollar trust if they can wait until their mid-20s or early 30s,” said Joshua S. Miller, senior wealth strategist and managing director at CIBC Private Wealth in Boston. “They want kids to get out of college, get a job, start working a bit, mature.”

Mr. Miller said he counseled clients not to let a trust be silent for too long. “A silent trust is a tool,” he said. “I feel strongly that values, legacy and stewardship are really important. I ask clients, ‘Are you able to talk openly about your wealth?’”

Cover your assets

Long ago, people went to foreign jurisdictions, like Switzerland or the Cayman Islands, to protect their wealth from creditors. But states have long since caught up, with Delaware, Nevada, New Hampshire and South Dakota revamping their trust laws to compete for high-net-worth individuals who want to shield their assets.

No state allows money to be shuffled into a trust in response to a lawsuit, a practice called fraudulent conveyance. But several states allow the transfer of money into a trust that would be protected after a period of, say, 18 months. A legitimate use could be by doctors or contactors who might be sued in the course of their career.

The money, though, cannot be commingled with other assets, said Matthew Hochstetler, a trusts and estates lawyer at David J. Simmons & Associates who practices in Ohio and Florida. And the process needs to look reasonable. He said he would advise clients to move no more than 50 percent of their wealth into an asset protection trust.

Bankruptcy judges do not look kindly on people who have separated assets for protection in a state like Nevada and cannot pay their debts in the state where they live.

“Bankruptcy judges love to put you in jail and hold you in contempt,” said Jerome M. Hesch, a retired law professor who runs a tax and estate planning institute at the University of Notre Dame.

But this is where the courts pit state against state. Generally, exceptions are made in the cases of alimony or child support, but states that allow self-settled trusts — in which the people setting them up are also the beneficiaries — have been challenged for not validating those support exceptions, particularly when the beneficiary lives in a different state.

“If you happen to live in a state with special asset-protection laws, there is nothing stopping you from taking advantage of your own state’s laws,” said Justin Miller, national wealth strategist at BNY Mellon (and no relation to Joshua Miller). “The real question, though, is whether individuals can set up a trust for themselves in a state where they don’t live and still avoid their own state’s law. Will your state respect it?”

Save on moving costs

Moving from a high-tax state to a one with low or no income tax is a well-known strategy. Of course, it requires the taxpayer to move. But there are other ways to save on income tax and still stay home.

Pulling certain assets out of high-income tax states like California and putting them into trusts in states with no income tax can save a huge amount of money. The highest rate in California is 13.3 percent; the rate in New York State and New York City combined can go up to 11 percent. Not paying that tax can be an enormous boost to an investor’s portfolio gains.

“All income reported by a Nevada or Delaware trust pays federal income taxes but no state income tax,” Mr. Hesch said. “If the people don’t need the money, it accumulates for the future.”

The only caveat is that the losing state does not always take the loss gracefully.

Original Article in The New York Times