An Incomplete Gift Non-Grantor Trust, or “ING” is a type of irrevocable trust established to potentially reduce or eliminate state income taxes for individuals who live in states with high income tax rates. These trusts are typically created in states that do not tax trust income and gains with the intention of avoiding or minimizing state income taxes on the assets placed into the trust. Grantors who are high-income earners, have significant unrealized capital gains on the sale of an asset, such as a business, and live in a high-income tax state may benefit from using an ING as part of their financial strategy.

Gifts to Incomplete Non-Grantor Trust are considered “incomplete” for federal gift and estate tax purposes. Incomplete gifts are so named because the grantor may retain control over or access to the contributed asset. ING trusts are non-grantor trusts, which means that the trust is the taxpayer for income tax purposes. This allows the income from trust assets to be taxed based on the residence of the trustee rather than that of the grantor. For grantors living in a high-income tax state, this can offer significant tax savings. If, for example, the sale of a highly appreciated asset is anticipated, doing so through an ING trust could limit the capital gains tax which might be higher if done under the laws of the grantor’s state of residence.

How INGs Work

An ING trust strategy works exceptionally well if a client lives in a high-income tax jurisdiction and is either looking to eliminate state income taxes or is selling an asset with a significant capital gain.

Here is how a ING strategy works:

1. The grantor transfers an asset or brokerage account with income tax liability to the ING trust. This is often a portfolio of marketable securities or shares in a family business.
2. Once the transfer is complete, the grantor is no longer responsible for the income tax liability because an ING is a non-grantor trust. As a non-grantor trust, the trust will be a separate entity for federal income tax purposes and will file a Form 1041 return.
3. The trust is responsible for the income tax, and if the trust is set up in a state such as Alaska, Nevada or Delaware, where there is no state income tax on trusts, the income earned on the assets in the trust is not subject to state income tax.

Important Considerations for ING Trusts

• Avoiding Source Income from High-Tax States: An ING works well if it owns intangible assets, such as shares in a business or a brokerage account. However, ING trusts cannot own tangible assets or assets sourced to the state in which the taxpayer resides. For example, if the asset is physically located in a high-income tax state (source income), the strategy will not work. Sometimes, tangible assets can be converted to intangible assets, but this requires additional careful planning with the help of specialized legal and tax advice.
• Not Everyone Can Use an ING: An ING trust may not work for all grantors, depending on the state in which the grantor resides and how that state views the taxation of a trust. New York and California, for example, have enacted laws to negate the use of the ING trust strategy. Other states automatically impose a state income tax if the grantor is a state resident when the trust is established. Therefore, consulting knowledgeable tax and legal advisors is critical to determine whether the ING trust strategy will work in a particular case.
• Highly Complex Strategy: INGs are complex trust structures that must be drafted according to specific rules to achieve the planning benefits. An experienced attorney should draft an ING trust to ensure it is a non-grantor trust per IRS regulations. Having a properly drafted trust is crucial to shift the income tax liability away from the grantor and to the trust.

It is important to note that the use of Incomplete Gift Non-Grantor Trusts (ING Trusts) raises complex legal and tax considerations. Tax laws can vary widely between states, and they may change over time. Additionally, the effectiveness of these trusts depends on the specific circumstances of the grantor and the trust’s compliance with relevant tax regulations. Therefore, individuals considering such trusts should seek professional guidance and stay informed about changes in tax laws that may affect their trust planning.

Note: The information provided here is for general educational and informational purposes only. It is not legal advice and should not be interpreted as such. For a thorough understanding of these topics relevant to your specific circumstances, we recommend consulting a qualified estate planning attorney. Peak Trust Company cannot provide legal advice; however, we can serve as an informational resource and provide referrals to highly skilled attorneys who can offer legal and tax guidance tailored to your specific needs.