Michael D'Addio, Tax & Business Services Principal, Quoted in Bloomberg BNA 2015 State Tax Outlook Special Report Article, "Changes in 2015 for Trusts and Estates."
By Rishi Agrawal
Trust Taxation and Residency.The upcoming year brings continuing trust residency issues in need of resolution. “The hodgepodge of residency rules [across the states] creates certain difficulties,” said Michael D’Addio, principal at Marcum LLP, in a Jan. 5. phone interview.
Bloomberg BNA’s 2014 Trust Nexus Survey (Sept. 26, 2014) illustrates how double taxation arises from the lack of a uniform trust residency law across the states. Factors used by states to determine a trust’s residency may include: where the trust is administered, the location of the trust’s assets or the residency or domicile of trustors, trustees or beneficiaries.
When a trust is a resident trust under a state’s law, the state may tax the trust’s entire income. Double taxation becomes a concern because trust residency laws vary so much among the states that a trust may be considered a resident trust in more than one state, and thus, taxable on its entire income in multiple states.
Incomplete Gift Non-Grantor Trusts. Some taxpayers attempt to avoid state income taxes imposed on trusts by setting up Incomplete Gift Non-Grantor trusts (IGNGs) in states such as Delaware and Nevada, which are commonly referred to as DINGs or NINGs respectively. IGNGs are carefully drafted trust documents that allow the grantor to retain enough control that any transfer is not deemed a gift, but the grantor must give up enough control that he or she is no longer considered owner of the trust assets so that the tax on retained income is taxable to the trust, which is located in a state that does not tax the trust’s income.
However, the federal net investment income tax frustrates the purpose of creating IGNG trusts, so they are falling out of favor as state tax-saving instruments. Individuals who create IGNG trusts are “primarily motivated by the state income tax savings,” D’Addio said. “If you are going to structure a trust that is suddenly going to incur the additional federal net investment income tax, it offsets the tax savings expected from reducing the state tax incurred, which is one of the reasons people will not pursue [IGNGs] as much as they want” he added.