After learning what ING trusts are and how they work in Part 1 of this series and reviewing the planning opportunities and uses ING trusts afford in Part 2, we conclude this three-part series with a look at potential issues and considerations to be aware of when establishing ING trusts.

Though certain powers are retained, preserving some level of control to the grantor, the assets are still being transferred to a separate party to maintain and administer. The relinquishment of complete control in exchange for a much lesser level of control should be noted. The grantor is no longer able to treat assets held in the trust as if they were his or her own.

To expand on this reduced level of control, a power-of-appointment committee acting in conjunction with a distribution trustee is a standard configuration for an ING trust and often used. The power-of-appointment committee is typically composed of other members with a beneficial interest in the trust, making them adverse parties.

The distribution trustee is often an independent third-party trustee, such as a professional trust company. Some combination of these roles is necessary to ensure that incomplete gift and nongrantor status are both maintained. Certain modifications to the trust agreement, such as the removal of the power-of-appointment party or distribution trustee could cause the treatment to change for purposes of gift tax, income tax or both.

In general, distributions should be made with caution. Distributions to a nongrantor beneficiary may result in a completed gift, causing utilization of the grantor’s lifetime exclusion or, if the donor’s lifetime exclusion has been exhausted, gift tax owed. Distributions back to the grantor may trigger state income tax and/or some form of accumulated earnings tax, depending on the grantor’s state of residence. Distributions back to the grantor without the proper checks and balances in place or distributions made that clearly indicate the grantor did not relinquish control may cause the trust to be reclassified as a grantor trust.

The trust’s underlying assets should also be considered when making any distributions of assets.

Certain assets, such as installment notes, which are common in ING trusts, may have surprising income tax consequences upon distribution or transfer. (For example, under Sec. 1038(g). For more on Sec. 1038 (in a nontrust context), see Homsany, “Seller Beware: Repossessions in Real Estate Installment Transactions,” 56 The Tax Adviser 40, January 2025.

Lastly, the economic substance of the ING trust may be scrutinized. Simply establishing a trust to obtain favorable income tax treatment where there is no actual change in economic position could lead to the whole transaction being challenged. In determining whether a trust lacks economic substance, courts will analyze the facts and circumstances of the trust, including, but not limited to, the following factors:

• Whether the taxpayer’s relationship as grantor to property purportedly transferred into the trust differed materially before and after the trust’s formation;

• Whether the trust had a bona fide independent trustee;

• Whether an economic interest in the trust passed to trust beneficiaries other than the grantor; and

• Whether the taxpayer honored restrictions imposed by the trust or by the law of trusts (Markosian, 73 T.C. 1235 (1980), at 1243—45).

Recent developments

To prevent resident taxpayers from avoiding state income taxes by establishing ING trusts in more taxpayer-friendly states, certain states such as New York and, more recently, California have rendered the use of ING trusts largely ineffective for state income tax minimization purposes by passing legislation that treats ING trusts as grantor trusts (N.Y. Tax Law Sec. 612(b)(41), enacted in 2014, includes trust income in the taxable income of a resident individual “who transferred property to an incomplete gift non-grantor trust.”).

California passed S.B. 131 in 2023, which included the addition of Section 17082 to the California Revenue and Taxation Code. The newly enacted law states the following:

For taxable years beginning on or after Jan. 1, 2023, the income of an incomplete gift nongrantor trust shall be included in a qualified taxpayer’s gross income to the extent the income of the trust would be taken into account in computing the qualified taxpayer’s taxable income if the trust in its entirety were treated as a grantor trust under Section 17731 (Cal. Rev. & Tax. Code Sec. 17082(a)).

This means that, for California state income tax purposes, the ING trust will be treated as a grantor trust. The income of the trust will be taxed to its grantor regardless of trust situs or distributions made.

In the case of California and, likely, other states that pass similar laws, the treatment is on a prospective basis. Previously earned income not distributed and not yet taxed by the grantor’s state of residence remains untaxed.

Solutions and alternate paths forward

If new legislation in the taxpayer’s state of residence has affected the intended use of an ING trust, there are potential solutions or alternate paths forward. Below are a few options for existing ING trusts:

Complete the gift: Legislation such as California’s newly passed law only targets incomplete gift nongrantor trusts. Modifying the trust agreement to remove any retained powers causing incomplete gift treatment may be a viable option if the grantor has sufficient lifetime gift and estate tax exclusion remaining. The increase in the annual exclusion due to inflation adjustments may have created enough exclusion to cover the amount of the contemplated gift. As a reminder, if sufficient exclusion does not exist, this will result in gift taxes owed.

Take no action: Though income earned on a prospective basis may be taxable to the grantor for state income tax purposes, this may not be consequential enough to undo previous planning. There may be a considerable amount of previously undistributed, untaxed income that can continue to remain untaxed if no action is taken. As previously mentioned, depending on the state of residence, a distribution of previously untaxed income may result in a large tax bill due to an accumulated earnings tax being triggered.

Move to a different state: Depending on what is at stake, an option, though extreme, may be for the grantor to move to a state that does not have anti-ING laws in place. There may be an opportunity to establish residency for a specified period and then take any distributions as necessary. The rules for breaking residency can prove burdensome in some states, though, so the rules should be carefully reviewed prior to deciding on any relocation (See Doolittle and Klein, “Changing Domicile From a High-Tax State to a Low-Tax State,” 55 The Tax Adviser 54, December 2024).

Distribute trust assets back to the settlor and start over: Assuming the trust agreement allows for this and consent is obtained from the relevant parties, it may make the most sense to distribute all trust assets back to the settlor in complete liquidation of the trust, undoing any previous planning, and seek a new trust structure to accomplish the desired goal. While this may not sound like an ideal solution, it may be worthwhile to avoid an ING trust’s complexities and administration costs if the associated state income tax savings no longer exist.

Depending on the goals and desired outcomes, utilizing a different trust structure may be a possibility. Trusts such as spousal lifetime access trusts, spousal lifetime access nongrantor trusts, inter vivos qualified terminable interest property trusts, and certain beneficiary defective trusts may be viable alternatives to accomplish similar goals, though not without considerations and roadblocks of their own.

Flexibility and value

With the correct selection of states and proper planning in place, ING trusts can provide great flexibility and value to their grantors and beneficiaries. Even with certain states passing legislation to limit the use of these trusts for state income tax planning purposes, many other uses and benefits still exist.

Reprinted with permission from The Tax Adviser.