Taxpayers in high state income tax states such as California can reduce the imposition of state income taxes on investment portfolios that are transferred to a Nevada Incomplete Gift Non-Grantor (NING) Trust
1. The IRS Recently Approved the Use of a NING.
If you live in a state with high income taxes, such as California, and are looking for a way to significantly reduce that tax, there is an estate planning technique in Nevada that may be the solution you are looking for. Last year the IRS issued Private Letter Ruling 201310002 approving the use of the Nevada Incomplete Non-Grantor Trust (“NING Trust”) technique. This Private Letter Ruling confirms numerous letter rulings dealing with similar trusts formed in Delaware, as well as a California Franchise Tax Board Technical Advice Memo concerningthe taxation of discretionary trusts.
2. Benefits of Using a NING.
A properly structured NING Trust may permit a resident of a state with high income taxes to avoid state income taxes on interest, dividends and capital gains. The reason that the NING Trust is able to offer such benefits is that the trust is a hybrid structure between a grantor trust and a non-grantor trust, which combines beneficial qualities of each to create a powerful tax mitigation vehicle. The NING trust must be carefully drafted in order to avoid “Grantor” status by giving up a sufficient amount of control over the assets in the trust, but not giving up too much control, which would create a completed gift and trigger Federal gift tax obligations. The Grantor is the person establishing the trust. The income of a Grantor Trust is taxed to the Grantor, while with a Non-Grantor trust, the trust is a separate tax-paying entity and the trust is responsible for paying taxes on its income.
3. Characteristics of a NING.
The foregoing Private Letter Ruling provides that a trust must possess all of the following characteristics in order to qualify as a NING Trust (i) the trust is self-settled, and provides the Grantor with an ability to receive discretionary distributions; (ii) the Grantor is not taxed on the trust income in the Grantor’s state of residence because the trust is a non-grantor trust; and (iii) the Grantor has a non-general power of appointment, which means that the Grantor has the ability to decide when and how much trust property will be distributed and (iv) the assets transferred to the trust are transferred in a manner that does not constitute a complete gift.
4. Benefits of Nevada Trust Law
While many states have passed laws that permit the creation of a self-settled trust that creditors are not able to reach, the laws in Nevada are likely the most beneficial to those seeking to take advantage of this vehicle. The reason is that Nevada permits the Grantor of the trust to maintain a lifetime power of appointment over the assets in the trust, but does not permit creditors to reach the assets of the trust. In layman’s terms, the person setting up the trust may maintain control over the assets placed in the trust. As such, not only does this trust provide tax savings, but it also provides asset protection. However, one caveat is that pursuant to Nevada law, in order for the trust to qualify as a Nevada trust, the trust must have at least one natural person serving as trustee that resides in Nevada, or have a bank or trust company, located in Nevada, serve as trustee. Additionally, the tax savings only occur while the grantor retains only a discretionally right to receive distributions. If the grantor’s right to received distributions becomes fixed, or to the extent distributions from the trust are received by the grantor, then state tax liability would be incurred.
5. Example of Tax Savings.
Taxpayer, a California resident has $2 million investment portfolio that produces $120,000 of interest, dividends and capital gains each year. Given California’s current state of income tax rate of 12.3% on most high net worth individuals (13.3% on those with California taxable income greater than $1M), the taxpayer could save almost $15,000 each year in California taxes by transferring the portfolio to a NING. Additionally, if the taxpayer can reinvest the annual tax savings at six percent after tax return, the saving would grow to $542,995 after 20 years.