Part 1 of this three-part series defined ING trusts and how they work. Here, we look at planning opportunities and uses ING trusts afford.

The combination of nongrantor income tax status, along with incomplete gift transfer tax status, provides the potential for solutions to existing problems as well as many unique planning opportunities. Some of the key characteristics of ING trusts that allow them to be such useful planning vehicles are:

• The trust is treated as a separate taxpayer for federal income tax purposes.

• The trust is structured as a complex trust, meaning that absent any distributions, the income will be taxed to the trust.

• Since the transfer of assets to the trust is incomplete for gift and estate tax purposes, the grantor’s lifetime gift and estate tax exclusion will not be affected by the transfer.

State income tax minimization

State income tax planning opportunities may exist, depending on the grantor’s state of residence along with the trust’s state of domicile. Since the trust is treated as a separate taxpayer for income tax purposes, establishing domicile in a state with more taxpayer–friendly state income tax rules may be possible.

For example, an individual taxpayer in a state with a high income tax rate may wish to shift income–producing assets to a state with a lower income tax rate or, perhaps, no income tax at all. An ING trust may be a vehicle that the taxpayer can use to accomplish this goal.

To illustrate, a grantor may choose to establish an ING trust in a state such as Nevada that does not have a state income tax, creating a NING trust, and transfer income–producing assets or assets to be sold in the future to this trust. If all is structured properly and the grantor’s state of residence allows for this, the trust, as a separate taxpaying entity in the state of Nevada, would not be subject to state income tax on its nondistributed, nonsourced income such as portfolio income.

Income specifically sourced to a state other than Nevada would still be taxable to that state, and distributions of nonsourced income to the grantor would likely be taxable in the grantor’s state of residence.

Distributions back to the settlor

Since an ING trust is structured as an incomplete gift, distributions of income and principal may be made back to the settlor without the risk of adverse estate– and gift–related consequences. However, distributions should be made with caution to avoid the risk of the trust being reclassified as a grantor trust under Sec. 674.

For example, if distributions are to be made back to the settlor, they must be approved by a power-of-appointment committee and/or an independent trustee. Though not a requisite standard, limiting the amount that may be distributed back to the settlor to an ascertainable standard as defined in Sec. 2041(b)(1)(A) may provide an additional safeguard from any potential reclassification to grantor trust status.

Compared to other types of trusts, an ING trust’s ability to make distributions back to the settlor adds an additional element of flexibility in the event the settlor needs access to funds held within the trust.

Asset protection and privacy

While each state’s laws differ, certain states such as Nevada have favorable asset protection laws that shield the assets held in trust from the grantor’s creditors. Assets placed in a NING trust generally may not be used to satisfy debts or claims against the grantor arising from divorce, lawsuits, or other liabilities (Nev. Rev. Stat. Sec. 166.170).

Similarly, while strong privacy laws do not necessarily apply only to ING trusts, Nevada, like many of the states that allow ING trusts, has such laws preventing the details of trusts from being made public, meaning the identities of the settlor, trustee and beneficiaries remain private. For certain types of assets where ownership is made public, titling assets in the name of the trust could provide additional privacy (Nev. Rev. Stat. §§166.170 and 164.041).

Dynastic planning

An ING trust, if established in the right jurisdiction, can be structured as a dynasty trust: An irrevocable trust that can remain in existence indefinitely or for an extended period of time, allowing wealth to pass down to multiple generations while minimizing estate, gift and generation–skipping taxes.

Not all states allow dynasty trusts. Many states adhere to some form of the rule against perpetuities and limit a trust’s duration. Examples of duration limits include limiting the term of the trust to a life in being (a person alive) at the time the trust is created plus 21 years, or a flat 90 years.

States that permit ING trusts, however, often allow for longer trust terms. Nevada, for example, allows a trust to last for up to 365 years. When contrasted with the 90-year limit adopted by many other states, this term is significantly longer and, therefore, significantly more tax-efficient and advantageous for dynastic planning.

It is important to note that dynastic planning itself, much like asset protection and privacy laws, is not unique to ING trusts. Rather, certain states that permit ING trusts, such as Nevada, also provide a framework for dynasty trusts.

Qualified small-business stock planning

Under the Sec. 1202 qualified small business stock (QSBS) exclusion, some or all of the gain on the sale of stock issued by a domestic C corporation may be excluded from gross income if the requirements of Sec. 1202 are met.

To provide a very high-level overview of the exclusion, certain noncorporate shareholders who sell qualifying stock of a domestic C corp that they have held for more than five years can exclude from gross income the gain from the sale of the stock up to:

• $10 million, reduced by the aggregate amount of gain excluded under the QSBS exclusion attributable to dispositions of the corporation’s stock in previous years, or

• If greater, 10 times the aggregate adjusted bases of the QSBS issued by the corporation and disposed of by the taxpayer during the tax year [Sec. 1202(b)(1)].

As the name suggests, this exclusion applies to sales of stock in small businesses. To be a qualified small business, the issuing corporation must have had gross assets of $50 million or less at all times after Aug. 9, 1993, and before and immediately after the stock issuance [Sec. 1202(d)]. Again, this high–level overview is not intended to be comprehensive. The complete requirements and nuances of QSBS eligibility are beyond the scope of this article.

A $10 million capital gain exclusion alone would provide great value to most investors but implementing a strategy that incorporates ING trusts may allow for additional QSBS exclusions. Before going into the mechanics and support for this, it should be noted that there is risk involved with this technique, referred to as “stacking,” and its use falls within a gray area of the law (See Lederman and Casteel, “Qualified Small Business Stock: Gray Areas in Estate Planning,” < https://www.thetaxadviser.com/issues/2024/apr/qualified-small-business-stock-gray-areas-in-estate-planning/ > 55 The Tax Adviser 30, April 2024).

Sec. 1202(h)(2)(A), in conjunction with Sec. 1202(h)(1), provides that a transferee of QSBS, having acquired the stock by gift, will be treated as having acquired such stock in the same manner as the transferor and having held such stock during any continuous period immediately preceding the transfer during which it was held by the transferor.

In other words, if the eligibility requirements were met in the hands of the donor, they will also be met in the hands of the donee. The QSBS exclusion applies for income tax purposes on a per-taxpayer basis. An ING trust, as a nongrantor trust, is a separate taxpayer for income tax purposes. Thus, establishing an ING trust and funding it with QSBS requires no utilization of the grantor’s lifetime gift tax exclusion and may provide for (“stack”) an additional $10 million of QSBS exclusion.

Basis step-up at death

Though it may seem obvious, it should be noted that since the transferred assets are still includible in the grantor’s estate, the underlying assets of the trust generally will receive a step-up in basis to their fair market value at the grantor’s death [Sec. 1014(a)(1)]. This is a significant benefit to the trust’s ultimate beneficiaries, as it could largely reduce future gains on the disposal of inherited assets in their hands.

Other benefits

Other potential benefits of an ING trust include the deferral of gift tax and probate avoidance.

There is an opportunity to establish an ING trust with the intention of eventually completing the gift at a certain point in the future, all the while realizing the benefits described above prior to completing the gift in the future. Perhaps there is proposed legislation on the horizon with uncertain consequences, and the donor wishes to wait until he or she knows its outcome prior to making the gift. Alternatively, suppose the value of the asset being gifted is somewhat volatile in nature—the donor may wish to determine the trend in appreciation in the asset’s value prior to making the gift, or the donor may wish to make the gift once the value of the asset reaches a specified target value.

As with assets held in other types of trusts, probate avoidance is also a benefit of ING trusts. Probate can be costly and may result in unintended outcomes. The avoidance of probate is always a welcomed benefit.

What are some issues and considerations when it comes to ING trusts? Check out Part 3 of this three-part series.

Reprinted with permission from The Tax Adviser.