What to Know about Incomplete Non-Grantor Trusts (INGs)

The Incomplete Non-Grantor Trust (ING) has become an increasingly popular planning tool for high income earners, particularly those living in states with higher income tax rates, that has tremendous flexibility to address a variety of succession planning, wealth management and estate issues. The name itself is flexible because it can be used as an Incomplete Non-Grantor trust or Intentional Non-Grantor trust. An ING trust reaches its full potential when located in South Dakota, which allows for self-settled trusts, directed trusts, distribution trust advisors, no state income tax and no state capital gains tax.

How ING trusts work

Federal estate tax is imposed on estates in excess of an amount established annually by Congress.  A common estate planning strategy is to make lifetime gifts of certain assets—either to intended beneficiaries or to trusts created for their benefit.  However, this strategy often involves making “completed” gifts, meaning the person making the gifts must give up control. The value of those completed gifts is generally reported on a gift tax return and counted against the amount otherwise exempt from federal estate tax upon the subsequent death of the grantor. By contrast, a person can make an incomplete gift to a trust so as not to use any of their estate tax exemption and avoid filing a gift tax return. This incomplete gift feature gave the ING its name.

The federal estate tax exemption has increased significantly from $5 million per person in 2011 to over $13 million. The current $13.99 million exemption presents a greater opportunity for tax planning with INGs. A gift of the full current exemption amount is made to a trust and it is intentionally structured as a non-grantor trust, meaning the trust income is not taxed to the person creating the trust. This amount can then grow free from state income and capital gains taxes in the trust for the remainder of the grantor’s life. Because the gift is incomplete, the grantor can be a beneficiary of the trust during their lifetime and they have not used up any of their gift and estate tax exemption amount on lifetime gifts. Upon death, the assets are included in the grantor’s taxable estate but are eligible for stepped-up cost basis so that the beneficiaries do not pay capital gains tax on the assets they receive.

What are the benefits of ING trusts?

If a gift is made to a South Dakota trust with assets generating passive income that is not distributed to the grantor in their home state, South Dakota has the further benefit of limited home state income tax. South Dakota does not tax the income of trusts, providing a significant value to those living in high tax home states.

The benefits are not limited to simply moving an investment portfolio. Most high-net-worth clients have created wealth through private equity and real estate. South Dakota’s directed trust statute makes it easier for a grantor to fund the trust with real estate, private equity or other unique holdings, and to discount the value. When this liquidity occurs in the South Dakota ING trust, the intangible income tax is limited, the state capital gains tax is mitigated, and the full proceeds are available for reinvestment at the direction of the grantor. The grantor may hold a testamentary power of appointment over trust assets, meaning distributions to beneficiaries can be modified if desired in the grantor’s will. While ING trusts typically require the involvement of other trust beneficiaries in distribution and investment decisions in order to preserve non-grantor status, South Dakota trust structures allow tremendous flexibility for the grantor to direct and influence the investments of the trust.

Privacy and asset protection of ING trusts

Privacy and asset protection are two features available in ING trusts that are properly drafted in South Dakota. Some notable privacy benefits include:

• A family name does not need to be used for the trust. Additionally, the trust can serve as the organizer of a South Dakota LLC to hold the assets, acquire additional assets or contract with investment advisors.
• The LLC that holds the trust assets does not appear on a list of entities opened in South Dakota, nor is there a list of the owners of the LLC.
• Acquisitions or sales of private holdings can be done through the LLC, with a client directing the trustee in South Dakota to sign documents. This allows the family to direct an acquisition through an anonymous channel, keeping the family name off the potentially public records.

Asset protection is an available feature of a properly drafted South Dakota trust with a South Dakota LLC as an asset. Any lawsuit targeting the assets of the trust, the grantor or the beneficiaries must occur in South Dakota. All lawsuits involving trusts are automatically sealed in perpetuity, and there will be no public record of the proceedings.

Since the LLC is the owner of the assets, it is the LLC that is sued. South Dakota only provides a charging order, which is similar to a garnishment, as a remedy for those who would sue. There is no judicial foreclosure. Even if the charging order is in place, the cash distributed from the LLC to the trust cannot be collected if the proper South Dakota discretionary beneficiary language is used. When properly drafted, beneficiaries do not have an income interest in the distribution, nor a property interest in the trust that can be collected by the plaintiff’s attorney. These barriers to successful lawsuit collectively provide tremendous asset protection.

ING trusts drafted in South Dakota offer many benefits not available in other states. Reach out to me to learn more.

 This content is intended for informational purposes only and should not be construed as tax or legal advice.  You should consult with your own tax and legal advisors regarding your unique situation and needs. South Dakota trust services are provided by BTC Trust Company of South Dakota, a wholly-owned subsidiary of Bankers Trust Company.

Non-Deposit Investment Services are not insured by FDIC or any government agency are not bank guaranteed. They are not deposits and may lose value.