¶ 4101
Overview
Scope of the chapter. An incomplete-gift nongrantor trust is an irrevocable trust, usually self-settled, designed to produce two tax results that the Code reaches by different tests. For federal income tax purposes the trust is a separate taxpayer, because none of sections 671 through 679 treats the settlor or anyone else as its owner. For federal gift tax purposes the settlor's transfer to the trust is incomplete, because the settlor has kept powers over the disposition of the property that Treasury Regulation section 25.2511-2 treats as retained dominion and control. The trust therefore pays its own federal income tax, while the property transferred to it remains, for transfer tax purposes, the settlor's property, so that no gift tax exemption is used on funding and the property is included in the settlor's gross estate at death. This chapter examines how that combination is built, what the Internal Revenue Service has said about it and why states that tax their residents on worldwide income have legislated against it. It closes with the design and administration of such a trust today.
The purpose of the design. The structure's principal use is the avoidance of state income tax on income the settlor does not need. A resident of a state with a high income tax who holds appreciated securities, a concentrated position in a business about to be sold, or a portfolio producing substantial investment income can transfer those assets to a trust administered in a state that imposes no income tax on trusts. If the trust is a grantor trust, its income is taxed to the settlor where the settlor lives, and nothing is gained (see supra ch. 40). If the trust is a nongrantor trust funded by a completed gift, the state tax may be avoided, but the transfer uses the settlor's federal gift and estate tax exemption and the settlor gives up the property to others. The incomplete-gift nongrantor trust attempts to avoid the state income tax without either cost: the settlor remains a discretionary beneficiary, the transfer is not a taxable gift, and the property receives a new basis at the settlor's death because it is included in the settlor's estate.
Names. Practitioners name the trust after the state whose law governs it and in which it is administered: a DING in Delaware, a NING in Nevada, a WING in Wyoming and an SDING in South Dakota. The generic term in the rulings, the legislation and the literature is "incomplete gift non-grantor trust" or "incomplete gift nongrantor trust," abbreviated ING. New York uses the hyphenated form in its statute (see infra ¶ 4170.02); California uses "incomplete gift nongrantor trust" (see infra ¶ 4170.05). This chapter uses "ING trust" throughout, except in quotations.
Why the trust is self-settled. The settlor is a beneficiary of an ING trust, and the trust is therefore a self-settled trust exposed to the settlor's creditors in any state that does not protect self-settled spendthrift trusts. Creditor access matters to the tax analysis as well as to asset protection. If the settlor's creditors can reach the trust property, the trust's income may be applied in discharge of the settlor's legal obligations, which section 677 and its regulations treat as a ground of grantor-trust status. Treas. Reg. § 1.677(a)-1(d). It may also bring the trust into the settlor's estate in a way the design does not control. The ING trust is therefore established under the law of a state that permits self-settled spendthrift trusts, with a trustee resident there (see supra ch. 37; infra ¶ 4160.04).
Three taxes, three tests. The design works because the income tax and the gift tax ask different questions about who is adverse to the settlor. Under section 672(a), a person is an adverse party if that person has a substantial beneficial interest in the trust that would be adversely affected by the exercise or nonexercise of the power the person holds. A member of a distribution committee who is also a permissible distributee meets that test, and the settlor's powers exercisable only with that member's consent do not make the settlor the owner. For gift tax purposes, the regulations treat the settlor as holding a power the settlor shares with a person who lacks a "substantial adverse interest," and the gift tax regulations under section 2514 provide that a coholder of a power has no adverse interest merely because the coholder is a permissible appointee. Treas. Reg. §§ 25.2511-2(e), 25.2514-3(b)(2). The same committee member is therefore adverse for income tax purposes and not adverse for gift tax purposes. The estate tax follows the gift tax: the property over which the settlor retained powers is included in the settlor's gross estate under sections 2036 and 2038 (see infra ¶ 4180.07).
Plan of the chapter. Paragraph 4110 describes the structure that the Service approved in a series of private letter rulings issued from 2013. Paragraphs 4120 and 4130 examine the income tax and gift tax analyses. Paragraph 4140 considers the position of the committee members, which delayed the rulings for six years. Paragraph 4150 traces the Service's position, including its decision in 2021 to stop issuing rulings on the structure. Paragraphs 4160 and 4170 turn to the state income tax, first the reasons the trust works and then the New York and California statutes that treat it as a grantor trust. Paragraph 4180 addresses the federal overlays that affect the trust's value: the multiple-trust rule of section 643(f), the exclusion for qualified small business stock, the deduction limit for state and local taxes, and estate inclusion and basis. Paragraph 4190 sets out design and administration, with model provisions. The grantor-trust rules themselves are examined in chapter 40, and the state rules that determine where a nongrantor trust is resident in chapter 2 (see supra ch. 40; ¶ 280).
Relation to other chapters. The ING trust is one of three trust designs in Part IX that use the grantor-trust rules deliberately. Chapter 40 examines the intentionally defective grantor trust, which is a grantor trust for income tax purposes and a completed gift for transfer tax purposes, the reverse of the ING trust. Chapter 42 examines spousal lifetime access trusts, which are usually grantor trusts funded by completed gifts. Chapter 43 examines trust classification and cross-border trusts, including the foreign-trust rules that make a trust with a foreign trustee a grantor trust in many cases. An ING trust must be a domestic trust; a foreign ING trust with a United States settlor would be a grantor trust under section 679 whenever it has a United States beneficiary, and the settlor is one (see infra ch. 43).