While corporate tax inversions are getting all the press lately, there is another tax strategy - call it a "personal tax inversion" - that can help individuals avoid taxes. However, similar to corporate tax inversions, the personal version is becoming just as controversial. Earlier this year New York state, which was losing an estimated $150 million a year through tax avoidance, effectively closed this tax loophole for New York residents. Other states may follow, but until then, if you expect a windfall from a one-time gain or an investment account that you anticipate to produce significant income over the coming years, a personal tax inversion might make sense.
The personal tax inversion strategy is not right for every situation, but under the right circumstances, it can be an effective way to pay less state income tax. The technique, which works best if you live in a state with a high income tax - requires the use of an Incomplete Non-Grantor Trust. The Incomplete Non-Grantor Trust allows you to shift assets to another state with a lower or no state income tax such as Nevada or Delaware. These structures are also referred to as NINGs or DINGs to reflect the state (Nevada and Delaware, respectively) in which the trust is located. As Neil Schoenblum, Senior Vice President at First American Trust in Las Vegas, Nevada, explains, "The NING affords certain persons with significant investment income a rare opportunity to reduce their total tax cost by avoiding all state income taxes that might otherwise be imposed."
How a NING/DING Works
There are grantor trusts and non-grantor trusts. A grantor trust is established by an individual called the grantor. With a grantor trust, the grantor (i.e., you) is treated as owning the trust assets for income tax purposes, and as such, is responsible for any income tax due on the assets within the trust. For example, if you live in California and simply have a trust administered in Nevada, you will still be taxed as a California resident.
On the other hand, a non-grantor trust is where you place assets into the trust and give up enough tax strings so that you are no longer considered the "owner" for tax purposes. So now the trust itself and not you is responsible for paying the income tax. If the trust is administered in a tax-free state such as Nevada, the trust pays no state tax, but don't celebrate too soon. If you transfer assets outside of your control, you run the risk of having to pay gift taxes. So while you may avoid state income tax, you would most likely have to pay federal gift tax or at least use up your gift/estate tax exclusion if the drafting attorney isn't careful. A non-grantor trust isn't going to work well if that were to happen.
The solution is to use a NING or DING. The "secret sauce" of this structure is the careful drafting of the documents. The goal is to keep enough control that you don't get accused of gifting the assets and having to pay gift tax, but not retain so much control that you are responsible for state income tax. This is an advanced strategy that requires the guidance of a good estate or tax attorney. Estate planning and asset protection attorney, Steve Oshins, of Oshins & Associates in Las Vegas, Nevada says, "Nevada has become the go-to state for this technique. I have done more NING Trusts this year than ever before given the favorable NING Trust Rulings that the IRS has recently issued. People love to save state income tax."
An added benefit is that NINGs and DINGs not only provide tax minimization but also asset protection. If you are interested in minimizing state income taxes, have your advisers run an analysis to see if a Nevada Incomplete Non-Grantor Trust (NING) or a Delaware Incomplete Non-Grantor Trust (DING) will work for you.