Avoiding State Income Taxation on Portfolio Assets

Avoiding State Income Taxation on Portfolio Assets

It is not difficult to construct a trust that will permit an individual to avoid income taxation on portfolio assets in the jurisdiction where he or she resides. The trust is drafted in such a way as to avoid having the grantor of the trust receiving income distributions.  The client may, at some point in the future, receive a distribution of the untaxed income from the accumulation or principal in the Trust.  If the individual resides in a high tax jurisdiction, the savings equals the state income taxes that would otherwise be paid.  The States of Delaware and Nevada are popular locations for such trusts known as Delaware Incomplete Non-Grantor Trusts (DINGS) and Nevada. Incomplete Non-Grantor Trusts (NINGS).

The State of Delaware will not tax a DING if there is no beneficiary who is a resident.  Delaware permits the DING to take an income tax deduction for income that is accumulated for eventual distribution to a beneficiary who is a non-resident of Delaware. Because a DING is a non-grantor trust for income tax purposes, the grantor will not be taxed in his or her state of residence on the income earned by a DING.  This is the pillar on which a DING rests.

Nevada does not impose a state income tax on individuals or trusts; therefore, it does not require NINGs to use an accumulation deduction to avoid tax. Nevada trust companies and local attorneys are proponents of the strategy and it is most useful for residents of the high tax State such as California.

Assume a wealthy individual can save $30,000 in state income taxes and can reinvest the savings at 6%. After 20 years, the amount saved would grow to over $1,000,000 with reinvestments.

Grantors are not prevented from being permissible beneficiaries of principal.  Remember, once income is taxed and not distributed, it becomes principal and can be distributed for health, maintenance and support.  Clearly, any portfolio income not being consumed for support may benefit from this strategy.

A recent private letter ruling clarified some tax issues that existed with respect to DINGS and NINGS and we now expect renewed activity as the result.