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Thursday, December 19, 2013

Wealthy NY Residents Use DING and NING Trusts to Escape NY Taxes

EscapeBloomberg, Wealthy N.Y. Residents Escape Tax With Trusts in Nevada, by Richard Rubin:

Wealthy Americans looking to avoid state income taxes are moving billions of dollars in assets to trusts in no-tax states such as Delaware, Nevada and Alaska.

The maneuvers are getting fresh scrutiny from officials in states including New York, which is losing an estimated $150 million a year through such tax avoidance. As fewer Americans pay the estate tax and top earners in New York and California owe more state income taxes, wealth planners say their clients are looking for new ways to escape those levies.

The asset shifts mirror steps corporations such as Google have taken across national borders to lower the taxes they pay. Within the U.S., some individuals who want to sell companies that they built move shares from home states to out-of-state trusts so the gains won’t be subject to state income taxes. ...

States including Delaware and Nevada have waged a decades-long fight for wealthy Americans’ trusts, competing to write laws that make it easier to pass property across generations and protect assets from creditors. Nevada has no state income tax and Delaware’s tax doesn’t apply to out-of-state beneficiaries. ...

Using a Delaware Incomplete Non-Grantor Trust, or DING, wealthy residents of high-tax states take advantage of vague or conflicting definitions in state and federal laws. They can move assets just far enough out of their control so they aren’t liable for state income taxes without moving them far enough to trigger a 40 percent gift tax. Because the trusts are private, there is no comprehensive data on how much money has moved across state borders in recent years or how much revenue the high-tax states are losing. Nevada figures show that trusts there hold $18 billion in assets, up from $8 billion in 2008. ...

The use of out-of-state trusts isn’t a new strategy, especially for estate planning and asset protection. What’s changed in recent years is that wealth planners have become more focused on state income taxes. ...

[T]he federal government blessed the maneuvers in ... private letter ruling [201310002], released this year, ended a six-year hiatus on such decisions and ratified the Nevada counterpart of the DING, known as a NING. “The only purpose of setting up these trusts, near as far as we can tell, is avoiding state tax,” said James Wetzler, a former New York state tax commissioner and a member of the state’s tax commission who criticizes the Internal Revenue Service. “I’m literally at a loss to understand why they would issue these rulings.” ...

The DING and NING strategies illustrate how tax lawyers can exploit gaps in state and federal laws.

Trusts created by people before death typically come in two forms -- grantor trusts and non-grantor trusts.

The income generated by grantor trusts that isn’t distributed to beneficiaries is typically considered taxable income to the person who put the assets into the trust. The initial contribution of assets is, in many cases, considered a gift for estate tax purposes. For example, records released during the 2012 presidential campaign showed that Mitt Romney used a grantor trust to pass wealth to his children, moving some assets before they rose in value and paying annual income taxes on trust earnings as a way of making an additional tax-free gift.

A non-grantor trust works the other way. The trust pays income taxes on any gains, with the top federal income tax bracket of 39.6 percent starting at $12,150 of income in 2014.

The NING and DING are hybrids, structured so the individual retains enough control to avoid gift tax and cedes enough control to avoid income tax. “That’s like threading a needle being able to get both of those things at once,” Redd said. The gift is considered incomplete, meaning that it hasn’t fully passed to heirs and isn’t subject to the U.S. gift tax. That’s because the person establishing the trust retains some ability to decide who gets how much money. ... For income tax purposes, however, the trust is considered a non-grantor trust and pays its own taxes on undistributed income. That’s because the person establishing the trust gives up the ability to get money back from it without the agreement of a committee of family members. The crucial fact is that the income tax liability belongs to the trust, not the individual. That’s where state law comes in.

Nevada has no state income tax and Delaware doesn’t tax trusts unless the beneficiaries live in the state. New York’s tax law can’t touch the trusts if the trustees, tangible property and real estate are out of state and they receive no New York-sourced income.

The DING and NING don’t necessarily resolve estate planning challenges, because the money remains in the wealthy person’s estate. In the meantime, though, it can save significant state income taxes.

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So the assets in a DING/NING should probably be non-dividend stocks, right? The ING is liable for income tax, so give it assets but starve it of income, yes? So move stocks to the ING without federal tax consequences, it holds them and gets no taxable dividends so no federal trust income tax, and then distribute some of the stocks to beneficiaries through GRATs and avoid gift or income tax. The stocks will still hold the original (presumably low) basis, but the beneficiaries can elect when to sell and take those gains.

If I'm getting any of this wrong, someone please correct me. There's no reason an ING couldn't use a GRAT, yes?

Posted by: nl7 | Dec 20, 2013 12:14:40 PM