On July 10, 2023, California’s governor signed into law Senate Bill 131 which effectively closes a loophole in California’s state income tax law for so-called Incomplete Gift Non-Grantor Trusts, which were known by the acronym “INGs”. This change is retroactive to January 1, 2023, and a new section 17082 will be added to the California Revenue and Taxation Code to reflect this change.
In a nutshell, INGs were trusts formed in a state not having an income tax with the idea that a taxpayer in a state with a relatively high income tax could direct some or all of that person’s otherwise taxable income to their ING trust and thereby avoid some or all of the state income tax, and maybe also certain contribution taxes. Additionally, the investment on those moneys would build up outside of the income tax state, and similarly avoid state income taxation. It might also be possible for these trusts to avoid certain state taxes upon the death of the person avoiding the state taxes. The main players for this sort of trust business were Delaware (which had “DINGs”) and Nevada (which had “NING”s). The Center on Budget and Policy Priorities published an article on January 30, 2023, which goes into great detail on how ING trusts work and calling for states to close the loophole.
New York closed the ING loophole in 2014, but California somewhat inexplicably allowed the loophole to remain open until now, although the State Assembly was continually sniffing around the issue in the meantime. Anyway, the ING loophole is now closed in the Golden State as well.
It is important to note that the new California law does not require such trusts to be wound up, but only that the taxable income of those trusts will go back on the California resident’s California state tax return for tax years 2023 and beyond. There may be other reasons why somebody with an ING would want to keep it in place, such as for asset protection concerns, and so one probably should consult with their trust attorney to determine if any continued utility of an ING trust is worth the costs of keeping it in place.
This is not, of course, the end of folks trying to avoid state taxes. So long as there are disparities in the tax systems and rates between states, folks will look to arbitrage those differences. You can’t drive very long in my neighborhood without seeing a high-end car with Montana plates, and buyers keeping boats and airplanes out of state for a few months to avoid certain state taxes is commonplace. The same goes for state income taxes insofar as there will be those who will come up with new ways (if they haven’t already) for skinning that particular cat.
It should come as no surprise to anybody that the singularly most effective way of avoiding state income taxes — moving — has caused a steady bleed of population from the high income tax states of California, Illinois and New York to states lacking an income tax (or states having low rates) such as Nevada, Texas, Florida and a few others. These states have snow birds who migrated there for the warmer weather, debt birds who migrated there for the more favorable exemptions from creditors, and now tax birds too. But one might reasonably suggest that the problem is not people doing things, including relocating, to avoid high state income taxes, but with the high state income taxes themselves. A smart state would be well advised to spend some resources in evaluating alternative methods of financing its operations, because a loss of population due to taxes will eventually cause a death spiral where fewer folks have to pay even more taxes, thus causing more to move, thus causing those who remain to pay even more taxes, and etc. and etc., until the state government collapses entirely from lack of revenues. One might further suggest that California and New York appear to already be in the incipient stages of such a spiral.
The point is that INGs were not the first thing anybody has ever come up with to avoid state income taxes, and they will not be the last. A problem is, however, that avoidance of state income taxes can be as dangerous from a penalty, or potentially even a criminal, penalty as federal income taxes. Therefore, if approached with an idea about how to save state income taxes, it is critical to get a second tax opinion from an independent tax attorney, i.e., one not affiliated with or suggested by the promoter of the idea, just as one would prudently do in dealing with federal income taxes. Note further that even moving away can be tricky, as the high income tax states have various theories to try to keep their hooks in folks for sometimes years after they have set up their teepee elsewhere.
Again, getting good and independent advice is critical. As always.
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