The first thing you should know about ING trusts is that they apply to a limited group of people in very specific situations.
For more, see Build a Wall Around Your Assets.
Limits of ING Trusts
These trusts are for high net worth individuals with assets that have either gone up greatly in value or that the individual believes will appreciate greatly in the near future. Another use for these trusts is to hold assets that create a lot of income. The purpose of the trust is to shelter that income from state income tax.
Since ING trusts reduce or eliminate state income taxes, they are mostly used by people who live in states with high state income tax rates. California, for example, has a top rate of 13.3%. New Jersey’s top rate is 8.97%.
Unfortunately, if you live in New York, you are out of luck. New York outlawed non-grantor trusts in 2013. New York’s top state income tax rate is 8.82%.
3 Types of Trusts
There are two main types of trusts – grantor and non-grantor. ING trusts comprise a third, hybrid type.
When you create a grantor trust, all income, deductions, credits and so forth are reported on your individual tax return. Any taxes owed are your responsibility.
A non-grantor trust is different. It serves as its own taxing entity and all assets in the trust are treated as if owned by the trust. If the trust “lives” in a "tax favored" state with regard to state income taxes, beneficiaries of the trust may not have to pay state income taxes when assets are distributed.
An incomplete gift non-grantor (ING) trust combines some of the best features of the first two, resulting in tax advantages not found in any other type of trust.
Tax Advantages of an ING Trust
First, as a non-grantor trust, the assets in an ING trust are considered transferred for income tax purposes. You have no responsibility to pay taxes on those assets while they are inside the trust.
Furthermore, as mentioned above, if the trust lives in a state that does not tax trust assets the beneficiaries of the trust may avoid state income taxes when assets are distributed.
Finally, since you retain limited control of the assets, the transfer becomes an incomplete gift and is not subject to gift and estate tax rules. This means there will be no deduction from your lifetime estate and gift tax exclusion of $5.45 million ($10.9 million for a couple filing jointly).
For additional insights, see What Are Gift Taxes?
Where you set up your ING trust determines how it will be treated when taxes are due at the time assets are distributed.
Three states – Delaware, Nevada and, on occasion, Wyoming – are most commonly used for ING trusts because those states do not tax assets of trusts established there. This applies even if you live in another state.
To help cement status as an incomplete gift non-grantor trust, many taxpayers get a private-letter ruling (PLR) from the Internal Revenue Service. These letters establish that the assets making up the ING trust are incomplete gifts and otherwise “bless” the establishment of the trust.
Private letter rulings by the IRS are not cheap. The current fee for a private letter ruling is $28,300. Multiple beneficiaries can get an identical letter for their files for $2,700 each.
Additional Steps to Take
Timing is an important aspect of setting up an ING trust. Putting assets into a newly formed trust, selling them immediately and distributing money back to yourself would likely set off alarms.
Ideally, you should set up the trust and sell the assets a few years later. As for distribution, that should come within a reasonable period after the assets are sold.
The Bottom Line
Eventually the assets in the trust will be distributed – to you as the creator of the trust or to your beneficiaries. If your ING trust was properly set up – including attention to timing and the acquisition of a private-letter ruling, if appropriate – those assets should not be subject to state income taxes.
In addition, your lifetime gift and estate tax exemption will not have been affected and, depending on the state where the trust resides, trust assets may be shielded from creditors.