An Incomplete Non-Grantor Trust (ING) is designed to be a separate taxpayer for income tax purposes which receives assets without gift tax consequences. No gift tax is incurred because the gift is “incomplete,” and the income is not taxable to the grantor because the ING is a non-grantor trust. However, the income generated from the trust assets is taxed to the trust. An ING’s income is taxed only on the federal level when the trust is in a state without an income tax.
States that tax income use tax codes mostly copied from the federal Internal Revenue Code (IRC). This allows an ING to work favorably in a state without a state income tax. For example, California taxes neither distributions from an ING established in Nevada nor the ING’s grantor in California. The ING’s distributions are not taxed by California because the ING is in Nevada. California does not tax the grantor because the IRC does not, and California follows the IRC regarding the tax treatment of trust grantors. Meanwhile, Nevada does not tax income at all. The Californian grantor would still be taxed on distributions received, but would have the authority to decide whether there would be a distribution.
Governor Newsom proposed an Anti-ING law in his 2023-2024 budget that would tax the net income of INGs, defeating the primary purpose for most INGs. Governor Newsom’s proposal bears few details, but the law would take retroactive effect to the beginning of 2023. There does not appear to be a bill adopting this proposal as of this writing on March 28, 2023.
Anti-ING laws are rare but not new. Rather soon after INGs became popular, New York conducted a study resulting in a new law targeting INGs, enacted in 2014. In 2020, the California Franchise Tax Board (FTB) proposed an Anti-ING law derived from New York’s creation. Both are simple (within a tax law context). They define an ING, proclaim it a grantor trust, and tax its net income to the grantor. Particularly as the FTB’s estimate of the increased annual revenue ($17 million) is the same as Governor Newsom’s estimate, his proposal will likely adopt the FTB’s 2020 suggestion. However, the governor has not disclosed the text of the proposed law.
Political parties are never monolithic. Yet Governor Newsom’s power over his party was seemingly demonstrated last year through his victory over Proposition 30’s multimillionaire tax. With well more than a sufficient number of Democrats for two-thirds majority votes in the Legislature, Governor Newsom may soon make California the second Anti-ING state.
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