BY: TIMOTHY BARRETT
Trust Counsel, Argent Trust Company | (502) 569-7400
The advantages of forming a Tennessee Income Tax Nongrantor Trust (TING) received another boost with the Supreme Court’s recent unanimous ruling that the state of North Carolina had overstepped its authority when trying to tax trust income based solely on the residence of a beneficiary.
The question of state interest lies at the heart of the Supreme Court’s June 2019 ruling in the case of North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust. The Supreme Court’s decision generally means a trust beneficiary’s residence in a certain state (in this case North Carolina) is, absent additional state connections, an insufficient reason to impose a state tax on the trustee.
North Carolina was relying on a law that stated it may tax any trust income that “is for the benefit of” a state resident. The Supreme Court disagreed, ruling “that the presence of in-state beneficiaries alone does not empower a State to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain ever to receive it.”
That’s good news for TING beneficiaries who reside outside the state of Tennessee. One of the major benefits of a TING is that it’s structured to pay no state tax on the trust’s undistributed net investment income — that is, income from trust investments that the trustee does not pay out for its beneficiaries to spend.
Tennessee legislators created the TING structure to attract investment into the state and increase its tax base. While this sounds strange in a state that levies no state income tax and is busy phasing out its tax on passive investment income (the Hall Tax), it does attract investment assets that in turn can help spur economic growth.
How a TING Trust is Set-Up and Why It Works
The goals and process for creating a TING are:
- Shift the applicable state income tax from the grantor’s state of domicile to a trust located in a more favorable tax jurisdiction;
- Transfer shares in a family business or other highly appreciated assets to the trust;
- Direct the trust to participate in the sale of the business or asset so that the shareholders recognize the long-term capital gain from the sale;
- Allow the net income to accumulate in the trust without distribution to the beneficiaries;
- Therefore, the trust pays the federal capital gains rate on the sale of the assets and little or no state level taxes; and
- The Trust specifies that Tennessee law governs — even if the trust was created in another state — and that election grants Tennessee courts automatic jurisdiction over the trust and dictates that Tennessee law controls validity, construction, administration, the settlor’s capacity, and each fiduciary’s powers, obligations, liabilities and rights under the agreement.
Key Considerations for a TING Trust
To ensure that Tennessee will have jurisdiction over the trust, substantial trust administration must be performed by a qualified Tennessee trustee. That administration must include at least one of the following:
- The trustee’s principal place of business is in Tennessee;
- It maintains some trust records in Tennessee;
- It prepares or arranges for preparation of some income tax returns in Tennessee; or
- It simply has some trust assets held in any kind of account in Tennessee.
It’s important to note the Supreme Court’s ruling in the Kaestner case was limited in scope. In its opinion it held, “We do not decide what degree of possession, control, or enjoyment would be sufficient to support taxation.”
Our trust team at Argent Financial Group expects additional challenges to overreaching state income tax schemes targeting trustees. Certainly, there are state income tax laws on the books that are likely unconstitutional. Meanwhile, the ruling reaffirms our belief in the tax advantages a TING can have for individuals and families who are seeking to protect and grow their wealth for future generations.
To learn more about Tennessee-chartered trust advantages, contact Timothy Barrett at (502) 569-7400.