When it comes to estate planning, it's easy to focus on
what's going on federal level with capital gains, income and estate taxes. But state-level
taxes can take a relatively large bite out of clients' holdings. Consider the
fact that income taxes are 13.3% in California, but in a place like Nevada,
there's no income tax. Delaware, meanwhile, doesn't levy income taxes on trusts
if beneficiaries reside outside of the state. Hoping to save your estate
planning clients some money on state income taxes? Try a NING or DING — a Nevada
or Delaware Incomplete Non-Grantor Trust.
SAVINGS OPPORTUNITIES
There isn't a great deal of difference between NINGs and
DINGs. The biggest distinction is that Nevada has enhanced creditor protection
of trusts. The first involves a scenario
in which the client is a resident of a state with high income taxes, and he or
she contributes a low basis asset to a NING trust based in a jurisdiction that
doesn't tax trust income. If the trustee sells the low-basis asset, he avoids
state income taxes on the sale.
The second opportunity is a situation in which the client is
a resident of a state with high income taxes, and she contributes an investment
portfolio to a NING trust. The trustee continues to invest that portfolio and
avoids state income taxes on any gain. This second scenario is something that
advisers are more likely to see.
In an example illustrating the power of the NING, consider a
scenario where a client sells a $5 million business and resides in a state with
a 10% capital gains rate. Federal capital gains are at 20%, plus 3.8% for the
net investment income tax. The proceeds go into the NING, the client is on the
hook for $1.19 million in federal income taxes, but there are no state income
taxes — which would've been $500,000 had the client proceeded without the NING.
TAXING SOURCE INCOME
Before weighing this strategy, advisers need to consider the
resident's state income tax rules. Many states will tax source income —
wages and other pay for services performed in the U.S. Non-source income is key — that's the income
the client is trying to protect from state level taxes with the NING. Get
familiar with the rules of the client's state and determine if the NING is
permitted. What's most important is to know how the resident's home state taxes
trusts: Is it based solely on the residency of the grantor or the settlor? If
so, the NING may not work.
Other states tax trusts based on whether they're
administered in that state. Or they might be taxed on whether there are one or
more resident trustees living in that state — a potential trap in a state like
California.
BINDING RULES
If you're creating a NING in Nevada, at least one
trustee must be a natural person who resides there, a trust company that is
organized under federal law or state law to do business there — and it must
have an office in that state for the transaction of business.
Another requirement: At least one Nevada trustee must have
powers that include maintaining records and preparing income tax returns for
the trust. All or part of the administration of the trust must take place in
Nevada. As a result, you probably don't want your client's uncle who happens to
live in Nevada act as the trustee.
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