Article on Considering the Irrevocable Nongrantor Trust Technique

Alyssa A. DiRusso (Whelan W. and Rosalie T. Palmer Professor of Law at Samford University’s Cumberland School of Law) recently published an article entitled, Pro and Con (Law): Considering the Irrevocable Nongrantor Trust Technique, 67 Vand. L. Rev. 1999 (2014), Commentary on Jeffrey Schoenblum, Strange Bedfellows: The Federal Constitution, Out-of-State Nongrantor Accumulation Trusts, and the Complete Avoidance of State Income Taxation, 67 Vand. L. Rev. 1945 (2014). Provided below is the introduction of the article:

Are INGs rightfully the next big thing? Professor Schoenblum presents an artful argument as to why an ING—an incomplete nongrantor trust sited in a state with favorable local tax laws—can produce significant income tax savings and should be defensible from a constitutional perspective.2 Diplomatic in tone, Professor Schoenblum describes the technique without expressly endorsing it.3 Should estate planners be following this trend, or walking away?

Given its docile position in Private Letter Ruling 2013-10-002,4 which sanctions the technique from a federal income tax and gift tax perspective, the IRS is seemingly not to be feared. The U.S. Treasury, after all, has economic incentives aligned with the taxpayer here. If a taxpayer avoids state income tax by use of a trust, and the corpus of that trust grows over time (including the forgone state tax), larger amounts of income will be subject to federal income tax at the trust level or upon distribution to beneficiaries. The taxpayer wins, the federal government wins, and the state loses.

The states, whose already-strapped budgets take another hit from this technique, have an incentive to fight. New York is fighting mad already. A recent Bloomberg news article reported that New York’s state tax commission, led by former Comptroller Carl McCall, was looking for solutions to stop the tax bleed.5 The article quotes a commission member, James Wetzler: “The only purpose of setting up these trusts, near as far as we can tell, is avoiding state tax . . . . I’m literally at a loss to understand why [the IRS] would issue these rulings.”6 These were the drum beats of tax war.7 New York recently responded aggressively to the technique by enacting a statute declaring an ING to be a grantor trust for state law purposes, even though an ING is a nongrantor trust for federal law purposes.8 Professor Schoenblum argues that this new statute is “purely an effort to staunch the loss of revenue resulting from the movement of capital to other states” that is incompatible with Due Process Clause and negative Commerce Clause jurisprudence—so the battle persists.9

Until the conflict is resolved, though, practitioners are well-advised to consider Professor Schoenblum’s diagnosis of the risks and rewards of the technique, contemplating not just tax consequences but the constitutional landscape that lets a hundred tax flowers bloom. In response to his article, I would like to make two major points. First, I offer a suggestion as to how to make the technique of using an ING work better. Second, I explain why it might be better if an ING didn’t work at all.