California eliminates ING trust planning strategy for California residents

On July 10, 2023, California Governor Gavin Newsome signed Senate Bill 131, which eliminates a sophisticated planning strategy for California residents known as the incomplete nongrantor trust (ING trust). An ING trust is an irrevocable trust designed to reduce or eliminate state income taxes for individuals who reside in high income tax states. They are created in states that do not tax trust income and gains in hopes of getting rid of state income taxes on the assets transferred to the trust. California is certainly one of those high-income tax states; hence, Senate Bill 131 and its provisions attacking INGs.

How does Senate Bill 131 attempt to close the loop on INGs? INGs, although established as nongrantor trusts — meaning the trust itself is responsible for paying income taxes on any income earned by trust assets — are treated as grantor trusts under the new law. The result of this is that any income earned by the trust is taxable in California to the individual who established and funded the trust, effectively eliminating the income tax planning benefit of the ING. However, for existing INGs that fall within the parameters of the law, note that there may be other reasons for keeping the ING in place, such as legacy objectives, creditor protection, etc.

This change is effective retroactively to Jan. 1, 2023. Senate Bill 131 does contain one exception: if the ING is a nongrantor trust, makes an election to be taxed as a nongrantor California resident trust and distributes 90% or more of its distributable net income to a 501(c)(3), income from the ING will not be taxable to the grantor. 

California is the second state to eliminate the use of INGs, after New York in 2014. California residents who have INGs as part of their overall estate plans should contact their estate and income tax professionals to discuss implications. Moreover, it is certainly possible that other high-income tax states will follow. For residents of those states — Hawaii, New Jersey, the District of Columbia and Vermont, among others — this development is something to keep an eye on.

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