By Timothy Barrett, Argent Trust Company
A Tennessee Income Nongrantor Trust (TING) is at the heart of a trust strategy that enables a person who owns a highly appreciated asset, like a closely held family business, to reduce or eliminate state level capital gains taxes on the sale of that asset. While other states also have laws that support this strategy, Tennessee legislators adopted the best parts of other state’s laws to establish a TING structure that attracts investment into the state and increases 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), the TING is part of a comprehensive body of Tennessee trust law that encourages moving investment assets to Tennessee thereby spurring the state’s 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 law from the grantor’s state of domicile to a trust governed by a more favorable tax jurisdiction where no or little state tax is levied on the trust;
- Transfer shares in a family business or other highly appreciated assets to the trust;
- Direct the trustee 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.
However, every state that levies an income tax will seek to tax at least some of the income of a nonresident trust if that other state has a close interest in the trust or the trust’s assets. Some states think they have a sufficient connection to levy a tax on a nonresident trust if the settlor lives in that state, if a beneficiary of the trust lives in that state, if the trustee has an office in that state, or if any income earned in the trust comes from a business operating in that state, among other connections. That conviction can be misplaced.
The Supreme Court recently unanimously ruled that the state of North Carolina overstepped its taxing authority when it sought to tax trust income based solely on the residence of a trust beneficiary. North Carolina argued that its taxing authority included any trust income that “is for the benefit of” a state resident. The Supreme Court disagreed.
This 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, “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.”
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. That’s good news for settlors considering a TING trust 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 distribute to its beneficiaries to spend or pay out for their benefit.
Key considerations for a TING trust
To ensure that Tennessee will have jurisdiction over a trust established by a nonresident settlor, 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.”
I suspect that additional challenges to overreaching state income tax schemes targeting trustees will follow in the coming years. Certainly, there are some state income tax laws on the books that are likely unconstitutionally broad, reaching beyond reasonable taxing authority. Meanwhile, the ruling reaffirms our belief in the tax advantages that a TING, among the many other benefits of a Tennessee trust, can have for individuals and families who are seeking to protect and grow their wealth for future generations.