INGTrust Wealth Preservation Maximize your ING in 2021 Round Two (California Grantors)

Last month, I discussed proposed legislation in California relating to incomplete gift non-grantor trusts (“ING(s)”). If passed into law, the legislation will end certain tax benefits attributable to the use of INGs. My focus last month related to Nevada INGs (“NING(s)”). Many of our clients have NINGs and since my article last month, we are in the process of creating more NINGs. If the proposed legislation is passed into law, you may be wondering what will become of existing NINGs.

NING Trust Structure:

A NING is a Nevada trust with special provisions causing the gifts to the trust to be incomplete for gift tax purposes. The trust is a non-grantor trust which means it is separate as a tax entity from the person who creates and initially funds the trust (the “grantor”). The trust must have a Nevada trustee who is independent from the grantor. The beneficiaries of the trust should be contingent beneficiaries for the trust to have tax benefits; especially if the beneficiaries are California residents.

If you are expecting to sell an intangible asset such as stock in a company or membership interests in an LLC in 2021, the use of a NING can help you eliminate California state tax. If the trustee is a Nevada resident and the beneficiaries are non-California residents or California resident contingent beneficiaries, income not sourced to California is not taxed by California. California source income includes such items as rental income or any other type of income derived from the ownership, control, or management of real or tangible personal property within California, gains realized from the sale of such property, income from a trade or business conducted within California. The sale of intangibles by a non-California resident does not fall under the category of California sourced income.

New Proposed Legislation:

In November of 2020, in recognition of the viability of INGs, Legislative Proposal C (the “Proposal”) was presented at the California Franchise Tax Board’s (FTB) Stakeholders Meeting.  The Proposal has the introductory revelation of there being a “problem” from the standpoint of taxation.  The following is an actual quote from the Proposal:

“Problem

ING trusts are generally treated as taxable trusts. A California resident grantor is able to establish an ING trust with a nonresident trustee and transfer assets to that trust. By doing so, the taxable income of the ING trust, generally intangible income, is sourced to the commercial domicile of the nonresident trustee for California income tax purposes. (Revenue and Taxation Code (R&TC) sections 17742, 17743, and 17744.) This allows a California resident to transfer assets to an ING trust, with an out-of-state trustee in a jurisdiction that does not have a state income tax, and not pay California state income taxes.”

 If passed into law, the Proposal will eliminate tax benefits associated with INGs for California grantors. The Proposal will add a new Section 17082 to the Revenue and Tax Code to treat INGs as grantor trusts effective as of June 30, 2021. Thus, an ING established by a California resident, who is still a California resident as of June 30, 2021, will become subject to California income taxation on all income after June 30, 2021. The Proposal will allow California to tax income related to the sale of intangibles held by NINGs.

What to do with Existing NINGs:

If you have a NING and you lose the tax benefit  due to the Proposal, you still have options for the future of your NING as a useful tool in your planning structure.  Depending on the content of your NING, you may wish to simply leave it as it is and continue to benefit from the asset protection and estate planning afforded by the NING.  Although the initial purpose of the NING may have been tax optimization, if you are a California resident, the NING affords substantial asset protection and is a very strong estate planning instrument.

Alternatively, you may desire to no longer have the NING or you may need to have some of the structure of the NING changed to meet certain estate planning or asset protection goals.  For instance, it may be beneficial for the trust to become a completed gift non-grantor trust.  Getting assets outside of your estate through the use of a completed gift in 2021 should be a strong consideration given the possibility of the estate and gift tax exemptions changing to much lower levels in 2022.  Consulting with your distribution committee about making distributions to the beneficiaries now before the estate and gift tax exemption levels change may be a consideration.

There are many possibilities regarding the use of your NING absent the tax advantages of intangible asset income which you should consider in 2021. It is important to make those decisions in 2021 given the likelihood the estate and gift tax exemption levels will go below the current $11.7 million in 2022.

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Last month, I discussed proposed legislation in California relating to incomplete gift non-grantor trusts (“ING(s)”). If passed into law, the legislation will end certain tax benefits attributable to the use of INGs. My focus last month related to Nevada INGs (“NING(s)”). Many of our clients have NINGs and since my article last month, we are in the process of creating more NINGs. If the proposed legislation is passed into law, you may be wondering what will become of existing NINGs.

NING Trust Structure:

A NING is a Nevada trust with special provisions causing the gifts to the trust to be incomplete for gift tax purposes. The trust is a non-grantor trust which means it is separate as a tax entity from the person who creates and initially funds the trust (the “grantor”). The trust must have a Nevada trustee who is independent from the grantor. The beneficiaries of the trust should be contingent beneficiaries for the trust to have tax benefits; especially if the beneficiaries are California residents.

If you are expecting to sell an intangible asset such as stock in a company or membership interests in an LLC in 2021, the use of a NING can help you eliminate California state tax. If the trustee is a Nevada resident and the beneficiaries are non-California residents or California resident contingent beneficiaries, income not sourced to California is not taxed by California. California source income includes such items as rental income or any other type of income derived from the ownership, control, or management of real or tangible personal property within California, gains realized from the sale of such property, income from a trade or business conducted within California. The sale of intangibles by a non-California resident does not fall under the category of California sourced income.

New Proposed Legislation:

In November of 2020, in recognition of the viability of INGs, Legislative Proposal C (the “Proposal”) was presented at the California Franchise Tax Board’s (FTB) Stakeholders Meeting.  The Proposal has the introductory revelation of there being a “problem” from the standpoint of taxation.  The following is an actual quote from the Proposal:

“Problem

ING trusts are generally treated as taxable trusts. A California resident grantor is able to establish an ING trust with a nonresident trustee and transfer assets to that trust. By doing so, the taxable income of the ING trust, generally intangible income, is sourced to the commercial domicile of the nonresident trustee for California income tax purposes. (Revenue and Taxation Code (R&TC) sections 17742, 17743, and 17744.) This allows a California resident to transfer assets to an ING trust, with an out-of-state trustee in a jurisdiction that does not have a state income tax, and not pay California state income taxes.”

 If passed into law, the Proposal will eliminate tax benefits associated with INGs for California grantors. The Proposal will add a new Section 17082 to the Revenue and Tax Code to treat INGs as grantor trusts effective as of June 30, 2021. Thus, an ING established by a California resident, who is still a California resident as of June 30, 2021, will become subject to California income taxation on all income after June 30, 2021. The Proposal will allow California to tax income related to the sale of intangibles held by NINGs.

What to do with Existing NINGs:

If you have a NING and you lose the tax benefit  due to the Proposal, you still have options for the future of your NING as a useful tool in your planning structure.  Depending on the content of your NING, you may wish to simply leave it as it is and continue to benefit from the asset protection and estate planning afforded by the NING.  Although the initial purpose of the NING may have been tax optimization, if you are a California resident, the NING affords substantial asset protection and is a very strong estate planning instrument.

Alternatively, you may desire to no longer have the NING or you may need to have some of the structure of the NING changed to meet certain estate planning or asset protection goals.  For instance, it may be beneficial for the trust to become a completed gift non-grantor trust.  Getting assets outside of your estate through the use of a completed gift in 2021 should be a strong consideration given the possibility of the estate and gift tax exemptions changing to much lower levels in 2022.  Consulting with your distribution committee about making distributions to the beneficiaries now before the estate and gift tax exemption levels change may be a consideration.

There are many possibilities regarding the use of your NING absent the tax advantages of intangible asset income which you should consider in 2021. It is important to make those decisions in 2021 given the likelihood the estate and gift tax exemption levels will go below the current $11.7 million in 2022.