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How To Save On Income Taxes Using An ‘INGenius’ Trust

- February 8, 2021

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Anger rarely pays — unless you are painting it. In 2017, Sotheby’s auctioned an untitled Jean-Michel Basquiat painting described as a rage-filled, skull-like face that is “raw, uncensored, and fiercely magnificent.” Oh, and expensive too. It sold for a little over $110 million.

The seller had originally purchased the painting in 1984 for $19,000. It was expected to sell for about $60 million, so it was a big windfall — and a big tax bill.

Tax planning will be particularly important after Covid-19 because as some high-tax states appear to be gearing up to increase taxes in hopes of recovering post-pandemic losses partially due to lost tax revenues. The wealthy can save millions of dollars in taxes by moving from a state like California, which levies the nation’s highest top-bracket income rate at 13.3%, to states such as Florida, Texas and Nevada, which have no state income tax. New York levies a rate of 8.82%, and those living in New York City are subject to its income tax up to 3.876%. Elon Musk, Carl Icahn, Joe Rogan and Ben Shapiro are just a few big names saying goodbye to high tax states. These reactions are rivaling the rage of a Basquiat painting, but good tax planning can turn anger into art.

Put The ING In Tax Planning

A popular tax-planning tool for high-income earners is the incomplete gift, nongrantor trust, or ING. The transfer of funds to this type of trust is an incomplete gift, which means it is designed to be included in one’s estate, so it is primarily an income tax and asset protection tool. According to IRS trust rules, a completed gift means the grantor relinquishes their rights to the assets upon transfer. An incomplete gift, however, means the donor reserves the power to reclaim the title.

To set up an ING, you must first designate a state with low or no income taxes that also allows the creation of strong self-settled domestic asset protection trusts (DAPT). Delaware, Nevada and Wyoming are common, where these trusts go by the names of DINGs, NINGs and WINGs, respectively.

Second, you will retain a limited power of appointment over the trust, which is what makes any transfers incomplete. However, it also means you are not subject to any gift taxes for funding the trust.

Third, the trust requires a distribution committee made up of beneficiaries other than you. The committee is considered an adverse party thus allowing the trust to maintain nongrantor status.

Lastly, the trust should be funded with highly appreciated assets with a low-cost basis, such as marketable securities, business interests and/or real estate. While there are many benefits of this approach, the primary one is the state income tax savings for grantors living in high-income-tax states, which means the sale of the assets is subject to low or no state income tax.

To illustrate the potential benefits, we will assume the Basquiat painting was originally purchased in 1984 by a wealthy Hollywood actor, a California resident, for $10 million. He immediately gifted the asset to a NING trust set up for the benefit of his family. In 1984, the standard lifetime exemption was $2,300,000, which would have required this actor to pay gift tax on the $7,700,000 difference. Paying gift tax at that time might have been a hard decision for the average person, but this actor knew he was going to hold the artwork as a long-term investment. Thirty-six years later in 2020, the trustee of the NING trust chose to hire Sotheby’s in New York to market and sell the painting, which raised over $110 million. The sale would create a $100 million long-term capital gain for the seller, which would normally trigger a $13,300,000 state income tax bill (13.3% California state income tax) had the painting been owned personally. By tactically gifting ownership to a NING trust, the Hollywood actor in our hypothetical example would have avoided all state income tax saving himself approximately $13 million. It is a win that would have made even Gordon Gekko envious.

It appears that California will follow the state of New York, which eliminated the tax benefits of this planning technique in 2014, and could also say no to NINGs, DINGS and WINGs as early as 2022. In late 2020, a legislative proposal was presented to the California Franchise Tax Board. According to the California Legislative Proposal C executive summary, it aims to amend personal income tax laws “to require that the net income derived from an ING trust’s assets, be included in the grantor’s gross income and subject to California income tax.” This, coupled with President Joe Biden’s tax plan, which aims to increase taxes on the wealthy, may be a strong impetus to evaluate and leverage an ING trust to mitigate future taxes before the planning technique is nullified.

When the actor Charlie Sheen was once asked about his daily life, he answered, “It’s perfect. It’s awesome. Every day is just filled with just wins. All we do is put wins in the record books.” Had Charlie been the seller who sold the Basquiat painting at the then world-record price, he would have added another “W” to his records. A win may be awesome, but adding an ING trust would have made the sale “winnING.”

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DEFINITIONS

Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.