Adapting to New Tax Laws to Preserve Wealth

California Legislature
Consulting Group


What occurred? 

On July 10, 2023, California’s governor signed into law Senate Bill 131, which added a new section 17082 to the California Revenue and Taxation Code. The newly enacted Section 17082 was drafted to have the income of an incomplete gift non-grantor trust (INGs) be included in a qualified taxpayer’s gross income, essentially treating the trust in its entirety as a grantor trust. To understand the effect of this change in treatment, we must first discuss the differences between INGs from other commonly used trusts, particularly grantor trusts.

Incomplete Gift Non-Grantor Trusts

In the following pages, we provide a more detailed explanation of the elements that comprise these pillars, and some opinion-driven thoughts from the firm – enabling you to review some of the many ways to structure your plan. While every client’s plan is different, our goal remains the same: To deliver the Optimized Continuity Strategy that works best for your business – and your family.

California’s concern is particularly around the ability for residents to establish these trusts to avoid state income tax. As a non-grantor trust, an ING trust is a separate taxpayer from the trust’s grantor, and thus, when formed in tax-friendly states (primarily Delaware and Nevada, but other states have begun to play such as South Dakota, Wyoming, Tennessee, etc.), it may allow the minimization of taxes at the state level, especially on the sale of intangible assets. The ability for residents of California to create these trusts which allow for the avoidance of the state’s high-income tax has been a long concern for California and thus prompted this new law to now treat them as Grantor trusts.

The new law change in California to treat INGs as Grantor trusts is simply to force the flow-through of income earned on ING trust assets to resident Grantors in California, generating additional state income taxes previously out of reach for the state (this CA law change will have no bearing on the Federal Tax Treatment). California lawmakers believe this will generate around $17MM to $23MM in additional tax revenue every year.

Who does this affect and how? 

Under the newly enacted section 17082, any California-resident Grantor of an ING will have all the trust’s income includable in their gross income for taxable years beginning on or after January 1, 2023. All trust income, regardless of whether it is California-sourced income, will be included in the resident Grantor’s California income tax return. There are few exceptions to the new law change impacting the treatment of INGs, with the primary one being that any ING that distributes ninety percent or more of the distributable net income to a charitable organization is excluded from being treated as a Grantor trust. Although California was not the first to pass such a law (New York and Pennsylvania already have similar laws), California’s top tax rate of 13.3% presents a large concern for resident generators who may now be exposed to millions more in state income tax liability.

One thing to note about the new law change targeting the treatment of INGs is that it does not alter the treatment of completed gift trusts that are treated as non-grantor trusts.

What can be done in response?

With such a large potential increase in state income tax liability and few exceptions written into the law, many are most likely in despair over what can be done and what options they have. However, as with all estate planning, a key trait is to remain nimble and react to law changes, as changes to the law are inevitable and often broad in their effect. Although the options appear limited, there are still alternatives to allow clients to receive similar benefits. 

One option is the adoption and utilization of Completed Gift Non Grantor trusts, as an alternative to the ING trust. 

It is also possible to utilize an ING in tandem with a Completed Gift Non-Grantor Trust where the taxable income of the ING is actually considered “grantor,” to the Completed Gift Trust. 

We often see clients procrastinate on planning citing family reasons, vacation, busyness of the business, etc. It is normal. As with all issues estate planners and practitioners may be faced with, as time passes more obstacles become apparent and simply call for more options and solutions.

If you are impacted by this law change and find yourself needing help identifying options, please reach out to us at Addicus as we are always willing to discuss how we may be able to help.

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