A tax-planning vehicle with an unsightly name—a NING trust, short for Nevada Incomplete gift Non-Grantor trust—is more attractive now, thanks to a recent private letter ruling from the IRS. With a NING trust, you may lighten the heavy state income tax load that burdens investors in California, New York, and other high-tax states.
Paying high state taxes is particularly unappealing under the current tax rate structures. Individuals in the top tax bracket now pay a rate of 39.6% and a maximum 20% tax on capital gains and qualified dividends on the federal level. Moreover, upper-income investors have to contend the 3.8% Medicare surtax on certain investment income. Add state income taxes on top of the federal tax bill, and about half of annual investment income could end up going to pay taxes.
One way to minimize state taxes in high-tax states is to establish a “self-settled” trust in one of the handful of states that don’t have state income taxes. Such trusts are structured so that the person who creates the trust and its beneficiary are one and the same. So an investor in, say, New York, might create a trust in Delaware, transfer assets to the trust, and take distributions from the trust—but without having that distribution income subject to New York state taxes. As with most trusts, however, the devil is in the details, and if a self-settled trust is set up incorrectly, it could be tagged as a “grantor” trust. In that case, trust income is taxed to the grantor—who in this example would be subject to New York state taxes—rather than to the trust, which isn’t taxed because it’s in Delaware. Another tightrope: relinquishing enough control over trust assets to avoid grantor trust status without giving up so much that the transfer to the trust is considered a completed gift, which would be subject to gift tax.
Rules in some states offer another benefit: shielding assets in self-settled trusts from creditors. However, an IRS ruling issued in 2012 clouded the issue and suggested a drawback to using such a trust in Delaware, perhaps the most popular state for incomplete non-grantor trusts. In certain situations, according to the ruling, some assets transferred to a Delaware trust would be considered a completed gift.
Among no-tax states, only Nevada has a statute that lets trusts avoid that problem. And now the private letter ruling (PLR 201310002) has effectively approved this technique for self-settled trusts in Nevada. That could make NING trusts more attractive than self-settled trusts in other no-tax states. Keep in mind, however, that NING trusts are sophisticated arrangements, and creating one that meets your needs will require expert legal and financial guidance.
This article was written by a professional financial journalist for Forbes Financial Planning, Inc and is not intended as legal or investment advice.