Danger for DING Trusts Created by N.Y. State Residents

Governor Cuomo’s budget bill, released January 21, 2014, includes significant proposed tax changes including some specifically aimed at curbing the use of so called DING Trusts.  For some background on Delaware Incomplete Non-Grantor trusts see my previous blog here, https://withumonwallstreet.com/2013/10/02/ding-ning-whatever-just-save-state-and-local-tax/.

The proposed changes would institute a “throwback” rule similar to the one utilized by California. Such laws work to throw untaxed income distributed to a New York resident beneficiary back across several years.  That is, the income which accumulates in a non-resident trust (or exempt resident trust), untaxed by New York, would be treated as if it were distributed annually over some defined period of years when it is finally paid to a New York resident beneficiary.  Such laws remove much (but not all) of the advantages of utilizing a non-resident trust.  Note, the proposed throwback rule would potentially apply to all non-resident / exempt resident trusts, not just DING trusts.

There is also a proposed tax change specifically targeted to DING trusts (regardless of which state’s law the trust is created under).  This change would cause the taxation of incomplete gift, non-grantor trusts (DINGs/NINGs/AKINGs), to become decoupled from the federal income tax treatment and instead tax such trusts as grantor trusts for New York purposes.  According to the Governor’s memorandum, income that is earned by a trust generally may be included in the income of the grantor, the trust, or the beneficiaries of the trust in situations where there has been an incomplete gift to the trust.

The bill would also provide a credit for non-resident trust and exempt resident trust beneficiaries for taxes paid to other jurisdictions and require non-resident trusts and exempt resident trusts to file information returns, including the identity of the resident beneficiary and the amount of the accumulated distribution.

This bill would be effective immediately and be applicable to tax years beginning on or after January 1, 2014. To mitigate transition issues, however, the section excludes from tax: (1) distributions of accumulated income by exempt resident trusts (except ING trusts) made before June 1, 2014; and (2) income earned by ING trusts that are liquidated on or before June 1, 2014.

How likely is it that this bill will become law in its current form?  While the answer cannot be known with any degree of certainty, readers should be aware that this is not the first time New York has sought to deal with the DING issue.  In 2010, Governor Patterson’s New York State Executive Budget contained a proposal that would have eliminated the exemption from income tax with respect to many, but not all, exempt resident trusts.  The New York State Bar Association recommended the deletion of the DING provisions from the 2010 proposal as it believed the provision would face serious constitutional challenges.  Although the 2010 proposal was ultimately removed from the final budget legislation, the New York State Department of Taxation and Finance Office of Tax Policy Analysis issued a statement that New York state exempt resident trusts would be required to file New York State fiduciary income tax returns on a going forward basis, even though the trusts were exempt from New York State income tax liability. We understand that this reporting requirement was motivated, in part, by a desire to obtain a better understanding of the amount of income realized by New York state exempt resident trusts.

The current Cuomo budget proposal provisions directed at DING trusts adopt many of the recommendations of the New York State Bar Association.  Such suggestions were aimed at protecting the legislation from federal constitutional challenge.  Nevertheless, it is far from clear that the DING provisions will survive to become law.  But given that the legislation, if enacted in its current form, would be retroactive to January 1, 2014 subject to the transitional rules described above, any New York resident utilizing or contemplating a DING trust should be on notice.

If you have any questions regarding DING trusts or other tax planning concepts please contact your regular WithumSmith+Brown partner.

 

Tony Tuths

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