What is an Incomplete Non-Grantor (ING) Trust?
An ING trust is a trust you set up in which assets you transfer to it are not completed gifts for gift tax purposes, yet the trust is a separate taxpayer for income tax purposes. The primary purpose of ING trusts is to eliminate the state income tax owed on the assets in the trust.
The ING trust must be carefully drafted so that grantor trust status is not inadvertently triggered, while also giving you, as grantor, enough powers over the trust so that your transfer of assets into the trust are not treated as completed gifts for federal gift tax purposes.
ING trusts can only be set up in jurisdictions that allow self-settled asset protection trusts such as Nevada, Wyoming, Alaska, and New Hampshire.
When does setting up an ING Trust make sense?
ING trusts work best if you are a high federal income taxpayer, reside in a high-income tax state, and have assets you or your other trust beneficiaries don’t need to live on. If set up properly, there is no state income tax on the income earned from the ING trust assets so long as those assets remain in the trust.
Generally, you cannot set up an ING trust if you reside in a state which taxes non-grantor trusts based on the grantor’s residence. Some states like New York have passed legislation prohibiting the use of all ING trusts.
How do ING Trusts work?
Trustees of ING trusts may make distributions upon approval from a distribution committee, which should include trust beneficiaries other than you or your spouse. During your lifetime, the distribution committee should consist of at least two members (other than you or your spouse) and, if the distribution committee at any time has fewer than two members, no distributions should be made to you or your spouse until the distribution committee has at least two members again. ING trusts also give you as grantor the power to direct the trustees to make distributions for the health, education, maintenance, and support of beneficiaries other than you or your spouse. You can also be given a limited power of appointment, which is a power to change the trust’s beneficiaries either during your life or after your death to anyone other than yourself, your estate, your creditors, or your estate’s creditors.
Who can be beneficiaries of my ING trust? Can I be a beneficiary?
You can be a beneficiary of your ING trust, but you cannot be the sole beneficiary. They may allow distributions to you, your spouse, your descendants, or other named beneficiaries. During your life, distributions to a beneficiary other than you or your spouse must be approved by the distribution committee, either unanimously or by majority with your consent. Distributions to a beneficiary other than you or your spouse are treated as completed gifts by you to those beneficiaries at the time those distributions are made. Distributions to you or your spouse must be approved by the distribution committee – you cannot unilaterally authorize distributions to yourself or your spouse.
Do ING trusts still avoid state income tax if distributions are made?
Please note that ING trusts only avoid state income tax to the extent that the assets stay in the trust. If income distributions are made to one or more beneficiaries, the ING trust claims a distribution deduction, generally the lower of 1) the trust’s taxable ordinary income or 2) the distributed amounts in a given tax year.
The distribution deduction amount gets passed through to the trust beneficiaries who received those distributions on a Schedule K-1, and the trust beneficiaries must report the Schedule K-1 income items and pay the taxes on their own personal income tax returns. If the trust beneficiary who receives distributions lives in high income tax state, the distribution deduction amount is subject to that beneficiary’s state income tax rates.
Some states like California have throwback rules. So, if distributions from the ING trust are not made until later years, then even prior years’ undistributed income is “thrown back” and subject to California income taxation when a distribution is made to the California resident beneficiary.
What assets should I use to fund an ING Trust?
Ideally, you should fund the trust with low basis appreciated intangible assets such as a publicly traded stock portfolio or closely held business interests that neither you nor the other beneficiaries need to live on. If you fund it with assets you need that will be distributed back out to you or the other beneficiaries, the ING trust serves little purpose (since you or the beneficiaries who receive the distributions will owe state income tax personally on the distribution deduction amounts assuming the beneficiaries reside in states that have a state income tax).
Who can I name as trustees of my ING Trust?
For ING trusts, you should appoint an independent trustee and the trustee must be a bank or trust company or an individual that operates or resides in the ING state.
Is the ING Trust part of my taxable estate?
When you transfer assets to a properly drafted ING trust, you do not use any gift exemption, but the trust assets remaining at your passing are still includible in your taxable estate. Those assets will also get a stepped-up basis at your passing, which will eliminate capital gains tax on those assets at your date of death.
How do I go about setting up an ING trust?
Drafting an ING trust is complex, so it is critical that you find a qualified attorney with experience in setting them up. Your current estate planning attorney may not have the requisite experience but can work with an attorney who is qualified to set up ING trusts. They should also work with a CPA who understands the federal and state trust taxation laws of the state where you reside. The costs of setting up and then administering the trust include not just attorney and CPA fees, but the ongoing trustee fees paid to the ING trustee to administer the trust and annual federal income tax filings. In the past, taxpayers could request a Private Letter Ruling (PLR) from the IRS to bless the set-up of a proposed ING trust. However, in early 2021, the IRS stated that it will no longer issue PLRs on them until a Revenue Ruling, Revenue Procedure, or Regulations on such trusts is issued.
Before taking any action, you should consult with qualified attorneys and CPAs to understand the risks of ING trusts and confirm the assets you plan to transfer to it save enough in state income taxes to justify the initial and ongoing trust set-up and administration costs.