Incomplete non-grantor trusts exist for one purpose. If you’re one of California’s nearly 200 billionaires, or among the state’s large share of the nation’s wealthiest 1%, an ING trust enables you to “avoid state income tax altogether” on what you earn on enormous pots of financial assets—the many millions of dollars you can easily set aside to build up, untouched.
Your appetite for tax avoidance is sated by INGs and other schemes hawked by your enablers in the wealth defense industry. They hook you up with notorious tax haven states like Nevada, South Dakota, and Wyoming, which eagerly cannibalize the personal income tax revenue streams of their sister states by creating fertile ground for these schemes.
Oh, and if you’re not a member of the ultrarich financial elite? The lower you find yourself on the financial food chain, the more their shirked tax burdens fall on your shoulders—unless you press your legislators to enact laws that enable all Californians to roam within a safer financial habitat.
Gov. Gavin Newsom’s 2023 budget includes a proposal to “reduce tax avoidance by wealthy Californians” by abolishing the ING tax dodge. But it won’t make it into law without voters’ vigorous efforts to make it a legislative priority. Newsom’s proposal has struck a nerve among those who complain of the “prejudicial implications” for their profession, predict (without evidence) that this will drive out the “more affluent” from California, and threaten that the ING shut-down proposal will “invite a fight.”
Playing in the Dream Palace
California’s financial elite intermingle with each other, of course. Iconic billionaire Gordon Getty, for example, has hosted fundraisers for Newsom, whose father managed the Getty family trust for many years.
Focusing on the Gettys, Evan Osnos describes in colorful detail a story from today’s “golden age of élite tax avoidance,” which has eroded “trust in America’s mythologies of fairness and opportunity.” Two young heirs to the Getty fortune shield their massive wealth in a “dream palace of accounting innovation,” he reports. They engage, for example, in a Getty family ritual—jetting off from their California homes each quarter to shore up the contention that their trusts are run from tax haven Nevada when they’re probably run from California.
In a very public dispute over private advisory fees, the sisters’ former wealth defense adviser describes a “dubious tax avoidance scheme” that avoided $300 million in California personal income taxes for several family members—using a trust vehicle that looks suspiciously like an ING.
Skirting Close to Faking the Facts
In a recent report for the Center on Budget and Policy Priorities, Michael Mazerov and I explore in detail California’s ING trust problem, explaining that its success is founded on “using carefully drafted trust provisions that skirt close to faking the facts.”
A trust is a legal relationship in which a grantor gifts property in trust to a trustee to manage for the benefit of beneficiaries. If the grantor retains too many “strings of control,” the grantor trust is ignored for federal income tax purposes, and its income is included on the grantor’s personal return.
But if the grantor makes a complete gift, it’s a non-grantor trust that must pay tax on its income in the trust’s state of residence—unless the income is distributed to beneficiaries, who then pay the tax in their states of residence. Like most states, California follows these federal rules and imposes tax if the taxpayer is resident in-state. If a billionaire or ultrarich grantor lives in California and doesn’t want to move—and let’s face it, most won’t—their non-grantor trust will be taxed by California unless it’s resident somewhere else.
That’s easy for a California-based grantor to fix. Just hire a trustee based in a tax haven such as Nevada, Delaware, Wyoming, or South Dakota, and then jet around and pretend you don’t ever do trust business in California.
Tax avoidance mission accomplished? Not quite. The 40% federal gift tax, which kicks in after you and your spouse have transferred a mere $24 million in assets, will kill the economics of your scheme. And that’s where the “I” in ING comes in.
Enablers managed to persuade the IRS 20 years ago to bless an asset transfer as simultaneously “complete” for federal income tax purposes—making the out-of-state trust the taxpayer instead of the in-state grantor—and “incomplete” for federal gift tax purposes, making the original transfer not subject to that tax. Avoidance accomplished after all.
New York’s Elegant Solution
After a second wave of favorable IRS rulings a decade ago, use of ING trusts by ultrarich tax avoiders accelerated, catching the attention of the New York State Tax Reform and Fairness Commission, which recommended quick action to shut down the scheme.
Asked for its advice, the New York Bar explained that an ING’s “state income tax [avoidance] benefits are achieved only if the trust is a nongrantor trust for tax purposes.” Put another way, an ING “would not achieve the desired state income tax avoidance if it were characterized as a grantor trust.”
That’s precisely what the New York legislature did. As in California, New York’s personal income tax law conforms generally to the federal tax law, but “decoupling” in select circumstances from federal tax treatment is unremarkable and easy to accomplish. The legislature simply passed a law that treats an ING trust as a grantor trust.
The practical impact of this law change? The trust’s income is now included in the New York-resident grantor’s New York personal income tax return.
It’s been a decade since New York shut down ING-based tax avoidance. During that time, California, Illinois, Massachusetts, and other states with significant numbers of ultrarich residents have watched as residents most capable of paying their tax obligations chose instead to duck their obligations with INGs.
California’s Franchise Tax Board identified the issue and recommended a New York-style shutdown in 2020 but couldn’t find any legislative sponsors for the initiative. Inclusion of the ING shutdown in Newsom’s 2023 budget is a strong step forward.
Will Californians choose simply to sit and watch as the financial elite push their tax obligations onto you? Email your representatives. Call them. Go camp out in front of their offices. Demand that the General Assembly bring forward and pass Newsom’s proposed ING shutdown bill—now.
This is a regular column from public interest tax policy analyst Don Griswold, who’s also a senior fellow at the Digital Economist. Look for Griswold’s column on Bloomberg Tax, and follow him on LinkedIn.