Revisiting “The Revival of the ‘DING Trust’ -- Is It Here to Stay?” – Not in New York
November 05, 2020
By Scott Testa
Back in June of 2013, we published an article on the use of DING Trusts, a very useful planning strategy. Subsequent to the publication of that article, New York State adopted legislation that outlawed DING Trusts for fiscal years beginning after April 1, 2014. The law treats incomplete gift non-grantor trusts as grantor trusts in the case of New York residents. However, for those outside New York State, this strategy is worth further discussion.
Because the federal estate and gift tax exemption is so high ($11,580,000 in 2020; $11,700,000 in 2021) and with the availability of portability, estate planning is no longer the main focus of many taxpayers. In fact, with the cap on the state and local tax deduction and other changes by the TCJA, the focus has shifted to reducing federal and state income tax exposure.
For 2020, the top federal marginal income tax rate is 37% on earned income and short-term gains. The Medicare tax increases that rate by 3.8% for investment income generated by high earners. Those residing in high tax states such as New York, New Jersey and California can count on a combined federal and state marginal income tax rate of up to 54% in certain instances.
An income tax strategy that is frequently recommended by estate and income tax planners alike is the “Incomplete Nongrantor Trust” (known as the “DING” for Delaware, “NING” for Nevada or simply “ING” since a number of other states have thrown their “ING” into the ring).
Back in 2013, when the article was first written, we were excited that the IRS had resurrected this strategy in a number of private letter rulings (“PLRs”). Those PLRs indicated a willingness by the IRS to issue rulings with respect to this type of trust offering insight into proper structuring. Fast forward seven years, ING trusts have survived (except in New York State) as a viable planning opportunity.
An ING trust is structured so that it is not subject to state income tax and transfers to it are not considered completed gifts. Because of this structure, taxpayers can transfer assets to the ING trust, without incurring gift tax or using any of the taxpayer’s gift or estate tax exemption, and shelter those assets from state income tax. To accomplish this and still permit the taxpayer to access the trust’s assets, the trust must be established in a jurisdiction that provides asset protection to self-settled trusts (such jurisdictions include Delaware, Nevada, Alaska and South Dakota).
An ING is appealing to a taxpayer who has significant income generating portfolios or anticipates a liquidity event of highly appreciated assets, resides in a high tax state that will not tax a non-grantor trust domiciled in another state, and is seeking asset protection. As an extra bonus, under TCJA, a non-grantor trust provides federal income tax benefits such as an additional $10,000 state and local tax deduction, IRC Sec. 199A benefits and the deductibility of tax preparation fees.
In considering the design of the trust, it is extremely important to weigh the state income tax savings against the federal income tax cost of the income being taxed in the trust as opposed to an individual, especially given compressed trust rate brackets and the 3.8% Medicare tax on net investment income. Drafting the trust with flexibility enables the trustee to make distributions to those beneficiaries in a lower income tax bracket in the future, and thus minimize both federal and state income taxation.
Additionally, a thorough review of the state trust laws and income tax rules should be undertaken before implementing an ING in order to achieve the desired state income tax consequences, as many states assert taxation based on a grantor’s domicile, the trustee’s domicile, location of the assets, location of administration, or a combination of these factors, as mentioned above.
With the rise in the federal estate and gift tax exemption, state income tax planning for those residing in high-tax jurisdictions such as New York, New Jersey, and California is more prevalent. However, as noted above, ING trusts no longer work in New York as New York enacted legislation in 2014 taxing INGs as grantor trusts regardless of when the trust was set up. Those taxpayers residing in New York wanting to reduce state income taxes and willing to use their federal exemption should consider the complete gift non-grantor trust, also known as the “resident exempt trust.”
For those not in New York, the ING trust, if properly structured, can be used as a tool in a comprehensive financial plan which can be helpful in mitigating income tax for those holding income generating portfolios or anticipating a liquidity event. Individuals considering this strategy should seek counsel, especially due to the fluctuations in state law and the specific guidelines set forth by the IRS. Finally, these trusts do not provide for federal estate tax savings so they work best when combined with a well-thought out estate plan.
To illustrate the concept, assume a married resident of New Jersey expecting a $15 million gain from the sale of stock in a closely held business. The individual is considering transferring the stock into a DING trust created in Nevada. All gain will be considered net investment income for purposes of the Medicare tax. Capital gains will be taxed at 20%, a New Jersey state marginal income tax rate of 10.75% and Nevada state fiduciary income tax rate of 0%.
|No Trust||With DING Trust|
|Gain from Sale of Stock||$15,000,000||$15,000,000|
|Federal Capital Gains Tax (20%)||(3,000,000)||(3,000,000)|
|Medicare Tax (3.8%)||(570,000)||(570,000)|
|New Jersey Marginal Tax rate (10.75%)||(1,612,500)||0|
|Net After Tax||$9,817,500||$11,430,000|