The Trust that Bars Both Creditors and State Income Taxes at the Same Time

August 2, 2017

The IRS recently issued Private Letter Ruling 201729009 where the IRS again blessed certain tax aspects of a trust (known as an “ING” trust, which stands for an “incomplete non-grantor” trust) that protects against both creditors and state income taxes.

This trust is created using the laws of a state that impose no state income taxes, even though the creator (or “settlor”) of the trust or certain beneficiaries live in another state (such as California) that otherwise imposes state income taxes on that settlor’s or beneficiary’s income.

The settlor can place assets in these trusts beyond the reach of future creditors, thereby gaining asset protection, while being allowed to receive distributions back from the trust at any time that a panel decides, in its pure discretion. This panel is referred to as a trust committee, and is comprised of members selected by the settlor (which advisably includes beneficiaries, such as the settlor’s children). So yes, this is a self-settled trust (meaning the settlor is a beneficiary of the trust he created).

In the meantime, if the trust sells an asset that has a huge capital gain (even if the gain is the result of appreciation that occurred before the settlor placed that asset into the trust), the entire capital gain is not subject to state income tax (e.g., California’s 13.3% tax).

Furthermore, the settlor can place assets with unlimited value into the trust because these transfers are not subject to any federal gift taxation.

This new ruling is consistent with the view that this strategy works provided the trust does not terminate and revert to the settlor due to an attrition of the members able and willing to serve on the above-mentioned committee. Instead, under the facts in this ruling, if the committee ceases to exist, it appears no reversion occurs. Instead, the trustees remain as the only persons authorized to make distributions.

This ruling also states that the strategy works so long as there are no Tax Code Section 675 scenarios in play, such as (1) the settlor or settlor’s spouse borrowing funds from the trust without adequate interest or collateral requirements, (2) a power being granted to allow for a substitution of assets of equal value in exchange for trust-owned assets, (3) an independent trustee being able to make distributions to the settlor; or (4) a non-trustee voting on certain securities that the trust and non-trustee collectively hold significant voting rights.

By Edward D. Brown, Esq., LLM. CPA

Check out our latest blog “Having a Trust that is Both “Dated” and Irrevocable can be Hazardous to your Wealth”

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