When it seems like you’ve exhausted all tax-saving strategies, there still may be another one left. It’s called an Incomplete Gift Non-Grantor Trust (ING). An ING is an irrevocable trust designed to reduce or eliminate state income tax. It is typically used by high-income earners or those anticipating a significant capital gain event in the future and who live in a high-income-tax state. There are significant restrictions on using INGs but where they are permitted, they offer unique benefits.
How Does an Incomplete Gift Non-Grantor Trust Work?
The grantor (the owner or seller of an asset) gifts assets to an irrevocable trust but retains testamentary appointment power, meaning the grantor keeps the power to name beneficiaries of the trust at death. By reserving that right, the gift is considered incomplete for IRS tax purposes. As an incomplete gift, the assets in the trust will still be considered part of the grantor’s estate at death and the beneficiaries will receive a step-up tax basis.
What Are the Requirements for an ING?
There are several stringent requirements for an ING. First, the trust must be established in a state that allows ING trusts. Those states are Nevada (Nevada Incomplete Gift Non-Grantor Trust or NING), Delaware (Delaware Incomplete Gift Non-Grantor Trust or DING), Alaska, Ohio, South Dakota, and Wyoming.
Next, the trust cannot be subject to income tax in the grantor’s home state. Many states will tax trusts even if the trust is not located there. As a result, an ING offers no tax benefit to grantors living in these states: Connecticut, Illinois, Louisiana, Maine, Maryland, Michigan, Minnesota, Nebraska, Ohio, Oklahoma, Pennsylvania, Utah, Vermont, Virginia, New York, Washington DC, and Wisconsin.
A third-party trustee must also be named who resides in the state where the trust is located. The grantor cannot be the trustee but the trustee can be given discretionary power to make distributions to the grantor. However, to retain the non-grantor status, the trust must require the consent of a distribution committee before distributing funds to the grantor unless the state allows for a domestic asset protection trust (DAPT).
What Are the Advantages and Disadvantages of an ING?
The tax savings are the clear benefit of this plan, assuming the grantor’s home state allows for INGs. It may be most useful for business owners anticipating selling the business or going public because that would result in a one-time large tax bill. To minimize state taxes on the transaction, stock could be moved into the trust. However, they would need to be transferred to the trust well in advance of the sale/public offering so as not to inflate the value of the stock and/or cause the transfer to be disregarded.
As an example of how this would work, let’s say the owner of a tech start-up anticipated going public in three years. If the owner sells stock at that time, there may be a large capital gains tax at the federal level. At the state level, taxes may be even higher if there is no preferred capital gains rate and/or the owner’s home state is a high-tax state. With an ING, the owner can transfer the stock into the trust in advance. Then, when the company goes public, the stock is sold by the trust. Federal tax will still be the same, but the owner saves on state taxes.
Since the transfer to the trust is an incomplete gift, no gift tax is owed and it doesn’t reduce the lifetime estate and gift tax exemption of the owner of the asset. Also, as noted above, beneficiaries receive a step-up basis upon the death of the grantor. If the asset appreciated between the time the trust was established and the death of the grantor, the beneficiaries get the benefit of the higher basis amount so when they sell, there will be less taxable gain.
The downsides of an ING include its irrevocability. The grantor losses control over the assets, although as noted above, the trustee may be able to make distributions to the grantor. As a result, an important consideration is whether the grantor has sufficient funds for living expenses or may need the income from the assets that would be transferred into the trust.
Grantors should also calculate the amount of tax potentially being saved to determine whether those savings offset the costs of creating the ING.
INGs can be a useful tactic for saving taxes if your home state will not tax them as income. However, an estate attorney can advise you whether it is the best option for you. An experienced lawyer can provide information about INGs and other tax-advantaged planning strategies that might be relevant to your personal assets.
Importantly, proper estate and tax planning do not just focus on what happens after you pass. There are options for trusts that can have significant lifetime benefits. If you are interested in receiving a comprehensive estate planning and tax assessment, contact us for a consultation.