Incomplete Gift Non-Grantor Trust. Often, high-net-worth Californians tried to escape the highest state income tax in the country by relying on a legal loophole, the Incomplete Gift Non-Grantor Trust, or ING, trust.
They have a chance to transfer investment assets beyond the reach of California by establishing a trust in a no-income-tax state such as Nevada (a NING) or Delaware (a DING) and still claim some indirect benefits.
It was a well-known, though complicated, tax-dodge scheme. However, the state of California in 2024 shut that door with new legislation that essentially states that such trusts are resident in California with regard to taxation.
The fact that you have such trust indicates that it is no longer a tax haven, but has likely been turned into a tax magnet and needs attention. Talk to a tax professional (like an IRS audit lawyer) for help in these matters.
What Makes the ING Trust Lose Its Sting?
The main attraction of a DING or NING was that it was not a grantor of state purposes. As much as the grantor (you) retained some powers, the trust was designed in such a way that you were not regarded as the owner of the trust for state income tax. This implied that the trust itself, based in Nevada or Delaware, would be taxed, which would be zero. The revenue would evade the 13.3 percent top tax of California.
- This is swept away by the new law in California (mostly retroactive to the 2023 tax year), which redefines residency.
- Today, however, when the grantor is a California resident, the trust will be classified as a California grantor trust by the California taxing agency (notwithstanding its situs).
- That is to say, all the income of the trust is automatically transferred through and subject to taxes on your own California tax return.
Things are Better Understood Now
a) Retroactive Reach
The law is effective with respect to tax years the commencement of which is on or after January 1, 2023. You might already have a California tax liability that remains unfiled on the trust income of last year.
b) Your Tax Reality
You are now a funnel that takes your income straight to your 540 return. It has kept its administrative expenses and complications at the expense of the main tax advantage.
c) Potential Penalties and Interests
This income should be reported on the previous or current year California returns, failure which it may be severely subject to do so may result in severe penalties and interest in addition to the amount of tax due.
d) Federal Treatment
This is a change made at the state level. The trust can also continue to be a non-grantor trust in the eyes of the federal income tax, and this makes your filing somewhat more complex.
Actions You Must Take as Trust Owners
When you have a DING, NING, or the like, the most costly thing to do is nothing. A roadmap to shift to compliance and efficiency is:
1) Tax Compliance
Your CPA and trust attorney should now start computing and filing any amended or overdue California tax returns for the 2025 tax year.
Warrant to your tax preparer that he knows all about the trust and is ready to report its income on your 2026 California return. Hiring an expert (similar to a tax resolution attorney), would make your life easier.
2) Long-Term Review
Since the tax benefit has been done away with, compare the continuing administration cost and trustee fees and legal/compliance costs of the trust against the benefits retained (such as asset protection goals or non-tax estate planning goals).
Review with your estate planning team to determine what to do. Possible courses of action could be:
1) Decanting
Transferring the assets of the trust to a new streamlined and compliant trust.
2) Modification or Termination
In the event that the terms of a trust permit it, this can be changed to a purely Californian trust, or terminated altogether, and the property distributed back to you.
3) Visiting Other Jurisdictions
To individuals contemplating migration, one of the options that can still be successfully implemented, but with considerable relocation effort, is to create a new trust in a no-income-tax state.
It is a narrow cross-border of trust law and tax law. Un expert advice on changes will result in the unintended consequences of the federal gift tax implications or the loss of other possible protective benefits. Your group should consist of a California estate planning lawyer and a CPA who is well informed with taxes on a trust.
The days or so of the out-of-state ING trust to avoid California tax are past. Something that was a shield is now a lens, and the state tax liability turns squarely back to you. The first thing to do is obvious: to obtain short-term compliance in order not to get fined and then perform a deep analysis to determine whether the existing format of the trust still makes sense in your financial plan. Being proactive on this change will help you to substitute a dead tax plan with an efficient, compliant future tax plan.
