The promise of avoiding taxes on income is enticing, and promoters of non-grantor, irrevocable, complex, discretionary, spendthrift (NGICDS) trusts promise essentially that. However, as the saying goes, if something sounds too good to be true, it probably is. In August 2023, the IRS issued a rebuttal to NGICDS trusts, stating that the marketing claims are based on a misinterpretation of IRC 643 and do not provide the promised tax benefits.
An NGICDS trust is formed by a third-party settlor acting on behalf of the party funding the trust (defined in the memo and here as the “Taxpayer”). The Taxpayer is appointed the “Compliance Overseer,” and, while not named as a beneficiary, has the power to change beneficiaries and trustees. The trust is funded primarily by the Taxpayer selling assets (such as real estate or interest in a company) to the trust in exchange for a promissory note, with the presumption that these assets will be leased back to the Taxpayer.
These trusts aim to provide an income stream to the Taxpayer protected from tax liability through allocating income to corpus, characterizing remaining income as an “extraordinary dividend”, and not making distributions to beneficiaries. To support their claims, promoters cite Section 643 of the IRC, and a private letter issued by the IRS Office of Chief Counsel.
However, the materials promoting NGICDS trusts quote §643 out of context, with the assumption that the income referred to in §643(b) applies to the trust’s taxable income. They fail to consider the beginning of §643(a), stating that the section specifically defines distributable net income (DNI) and not taxable income. DNI refers to the amount the trust can deduct for distributions to beneficiaries. The IRS cautions that “if a non-grantor trust does not make (and is not required to make) any distributions to its beneficiaries, then it is not entitled to any “income distribution deduction.” Promoters also fail to address §641, which holds that the trust’s taxable income is computed in a similar matter to that of individuals.
The complete IRS memorandum can be read here: https://www.irs.gov/pub/lanoa/am-2023-006-508v.pdf The memorandum includes a disclaimer that it is not comprehensive and “may not be used or cited as precedent.”
Due to the complexities of trusts and the codes governing them, there is a lot of bad advice out there, whether due to a misinterpretation of IRS statutes or deliberate misrepresentation. Before forming a trust, it is important to consult a qualified attorney and financial advisor to obtain accurate information and determine the correct trust for your needs.
Contributed by Elizabeth Green, Esq.