December 18, 2013

Wealthy avoiding taxes by moving assets to no-tax states

The asset shifts mirror steps corporations such as Google have taken across national borders to lower the taxes they pay.

By Richard Rubin
Bloomberg News

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At the same time, marginal state income tax rates have risen, particularly for top earners. For 2013, California applies a 13.3 percent tax rate on taxable income exceeding $1 million. The top state-and-local combined rate in New York City this year is 12.7 percent for income exceeding $1 million for individuals and $2.1 million for married couples.

Also, the federal government blessed the maneuvers in a ruling requested for a client by Lipkind, an attorney at Lampf, Lipkind, Prupis & Petigrow, P.C. in West Orange, N.J. The private letter ruling, released this year, ended a six-year hiatus on such decisions and ratified the Nevada counterpart of the DING, known as a NING.

“The only purpose of setting up these trusts, near as far as we can tell, is avoiding state tax,” said James Wetzler, a former New York state tax commissioner and a member of the state’s tax commission who criticizes the IRS. “I’m literally at a loss to understand why they would issue these rulings.”

That IRS ruling for a man with four sons, none of whom were named publicly, “resurrected this transaction from the ashes,” said Charles “Clary” Redd, a partner at Stinson Morrison Hecker LLP in St. Louis.

Steve Oshins, an attorney at Oshins & Associates LLC in Las Vegas, said he has moved billions of dollars in assets to Nevada, including some through NING trusts.

The DING and NING strategies illustrate how tax lawyers can exploit gaps in state and federal laws.

Trusts created by people before death typically come in two forms, grantor trusts and non-grantor trusts.

The income generated by grantor trusts that isn’t distributed to beneficiaries is typically considered taxable income to the person who put the assets into the trust. The initial contribution of assets is, in many cases, considered a gift for estate tax purposes.

For example, records released during the 2012 presidential campaign showed that Mitt Romney used a grantor trust to pass wealth to his children, moving some assets before they rose in value and paying annual income taxes on trust earnings as a way of making an additional tax-free gift.

A non-grantor trust works the other way. The trust pays income taxes on any gains, with the top federal income tax bracket of 39.6 percent starting at $12,150 of income in 2014.

The NING and DING are hybrids, structured so the individual retains enough control to avoid gift tax and cedes enough control to avoid income tax.

“That’s like threading a needle being able to get both of those things at once,” Redd said.

The gift is considered incomplete, meaning that it hasn’t fully passed to heirs and isn’t subject to the U.S. gift tax. That’s because the person establishing the trust retains some ability to decide who gets how much money.

In the IRS ruling involving Lipkind’s client, the man with four sons has the sole power to use the money for the health, education or support of his children.

For income tax purposes, however, the trust is considered a non-grantor trust and pays its own taxes on undistributed income. That’s because the person establishing the trust gives up the ability to get money back from it without the agreement of a committee of family members.

The crucial fact is that the income tax liability belongs to the trust, not the individual.

That’s where state law comes in.

Nevada has no state income tax and Delaware doesn’t tax trusts unless the beneficiaries live in the state. New York’s tax law can’t touch the trusts if the trustees, tangible property and real estate are out of state and they receive no New York-sourced income.

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