State income tax planning for the nonresident Floridian: the ING trust.

• Author: Karibjanian, George D.
• Position: Incomplete nongrantor

One of the major advantages of Florida domicile and residency is the absence of a Florida state personal income tax. To the Florida estate planning attorney, "state and local taxes" has been the specialty for which he or she "need not apply." Florida is also a very transient state, as residents come and go from northern states seemingly on a daily basis. This transient nature also flows through to the Florida tax and estate planning bars. To maintain client representation, many East Coast attorneys retain their bar memberships in states such as New York, New Jersey, and Pennsylvania, while many West Coast attorneys retain their bar memberships in states such as Illinois, Ohio, and Michigan.

With the knowledge that many part-time Florida residents choose to remain domiciled "back home," dual-licensed Florida attorneys must dust off the state income tax books and maintain their skills regarding their "home" state's income tax planning. This includes awareness of specific techniques to assist with such state income tax planning. For certain clients that 1) reside in states that impose a state income tax (state tax states); 2) have disposable assets they wish to benefit subsequent generations but still retain an interest in the assets "for a rainy day"; and 3) would prefer not to pay state income tax on the income earned from such assets, such a specific planning technique exists that utilizes a self-settled irrevocable trust. These trusts are commonly referred to as "ING trusts," with "ING" standing for "incomplete (gift) nongrantor" trusts.

The Basics

To follow the logic of the ING trust, three concepts must be understood. First, for state tax states, with respect to grantor trusts, the rules of subchapter J of the Code (1) apply to the particular state income tax. (2) Second, in certain states, such as Delaware and Nevada, no state personal income taxes are imposed (nontax state) and it may also be possible to create a self-settled irrevocable trust and have those assets be protected from creditors (domestic asset protection trust or DAPT). (3) Combining these first two concepts, the question is whether an individual domiciled in a state tax state can create a DAPT and have distributions come back to him or her without the imposition of state income taxes. This is the premise and foundation of the ING trust structure. With that understanding, the third concept of ING trusts is that ING trusts are not intended for transfer tax savings. The sole objective of the ING trust is state income tax savings--ING trusts involve incomplete transfers for transfer tax purposes and are anticipated to be included in the grantor's gross estate. (4)

While most DAPTs are grantor trusts, with the ING trust technique the DAPT is purposefully structured as a nongrantor trust and, therefore, becomes its own taxpayer. Since the DAPT is located in a nontax state, the DAPT's taxable income is taxed in the DAPT state, which means that, at least at the trust level, there is no state income tax. By way of example, suppose that Titus, a Massachusetts resident, creates a nongrantor trust Delaware DAPT at the end of 2013. In 2014, the DAPT earns $10,000 of distributable net income (DNI), none of which is distributed (such DNI is also fiduciary accounting income). The DAPT pays the applicable federal income taxes on the DNI. Because Delaware is a nontax state, no state income taxes are assessed on the DNI. The DAPT then provides that any undistributed fiduciary accounting income is to be accumulated by the trustees and added to trust principal. In 2015, the DAPT has $0 DNI, and, at the end of the year, the trustees effect a discretionary principal distribution to Titus in the amount of $10,000 (i.e., the same amount of 2014 undistributed DNI). Is that principal distribution taxed to Titus for Massachusetts state income tax purposes? Since the DAPT is a nongrantor trust, the only way that any portion of a distribution can be taxed to a beneficiary is if it consists of DNI, and since the DAPT had no DNI in 2015, it would appear the distribution is not subject to income tax. Titus ultimately received $10,000 in 2015 for which federal income taxes were paid in 2014, but for which no Massachusetts income tax is due. Thus, the combination of the Subchapter J rules and the DAPT rules allowed Titus to avoid Massachusetts income tax on the 2014 income.

The above is a basic example of the technique--the intervening steps are extremely technical and complicated.

ING Trusts and Subchapter J

The grantor trust rules under subchapter J rely, for the most part, upon powers retained by the grantor when approval is required of the grantor or a nonadverse party.

For example, the preamble to [section]677(a) states as follows:

(a) The grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under [[section]]674, whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be--. (5)

Thus, if distributions or certain powers must be effected with the approval of an adverse party, grantor trust status can be avoided. Compare this provision to Delaware law, which requires a Delaware DAPT to have a Delaware-based trustee and also limits the grantor's retained powers, two of which are that the grantor cannot be a trustee and the grantor cannot retain the power to control distributions. (6) Following those rules, it would seem that, unless a beneficiary who acts as the trustee lives in Delaware, the Delaware trustee would be a nonadverse party that triggers [section]677(a) and creates a grantor trust. The ING trust structure circumvents [section]677(a) by creating an intermediary --a "distribution committee" comprised of adverse parties--who direct the trustee as to distributions. The presence of the adverse parties causes [section]677(a) not to apply, so the ING trust is...