State income tax may be avoided if assets may be transferred into a non-grantor trust in such a way as to avoid the transferor making a gift. The typical acronym for such trusts is a DING Trust, for Delaware Incomplete Non-Grantor Trusts, but there is nothing magical about Delaware as the state in which the trust ought be created.
Typically, the grantor of the trust wants to be a beneficiary. Thus, in order to avoid grantor trust status the grantor may receive distributions only at the direction of adverse parties. Generally, some of the grantor’s descendants are beneficiaries of the trust and are thus thought to be adverse for income tax purposes, and thus are empowered to make distributions to the grantor.
The grantor also wants the transfer to be incomplete for gift tax purposes. In a string of rulings beginning in 2001 the IRS determined that a testamentary power of appointment in the grantor made the gift incomplete. See e.g. 200148028, 200715005, and others in between. In CCA 201208026 the IRS reversed that position, concluding that the testamentary power of appointment would only affect the remainder interest not the income or present interest. So, the trick is to give the grantor some power that will make the gift incomplete but that will not cause the trust to be a grantor trust for income tax purposes.
One such power is the grantor’s power to make distributions in a non-fiduciary capacity pursuant to a fixed and ascertainable standard under Reg. §2511-2 so long as retention of such power does not cause the assets of the trust to be subject to the grantor’s creditors because that would cause the trust to be a grantor trust for income tax purposes. Delaware does not protect trusts where a grantor has such a power but Ohio, Nevada and Wyoming do.
Another potential power would be to require the grantor’s consent before distributions were made to others. This power would pass muster in many of the asset protection states, including Delaware.
In IR-2007-127 (July 9, 2007) the IRS announced it was reconsidering its position on the gift tax consequences to the beneficiaries on the distribution committees. The IRS was likely spooked by comments from a professional group about the tax consequences of DINGs and the government’s arguably incoherent ruling position. However, without comment on what learning has been achieved, the IRS has begun issuing rulings in this area, on March 8, 2013 issuing PLRs 20131002 – 006. There the grantor had to give consent if a majority of the distribution committee wanted to make a distribution, but a unanimous committee could distribute regardless, and the grantor could distribute assets among the grantor’s issue for health, education, maintenance and support in a non-fiduciary the capacity. The IRS determined that the transfer was incomplete, the trust was not a grantor trust, the distribution of assets to the grantor was not a gift by the committee, and a direction by the committee to distribute to others is not a gift by the committee (although it would be by the grantor at that point). On the latter issue, the key structural issue would seem to be ensuring that the distribution committee members are adverse to one another. If a member is not replaced when failing or ceasing to serve, then the increasing control of surviving members appears to generate the necessary adversity.