Dodgeball - The Tax Version

by Gerald Nowotny


Since the passage of The American Taxpayer Relief Act of 2012 and the submission of the President's federal budget proposal for 2014, it is clear that high net worth and high income taxpayers continue to be under attack. Surprised?

Reacting to these "silver bullets" is like a game of grade school Dodgeball You hope that you don't get hit. I might mention in passing that after many years of heavy weightlifting and conventional sports participation, one of my worst sports injuries as a child or adult came through a game of Dodgeball. Clearly, it is not a game for sissies and I can promise you that the tax version of the game is not a game for sissies either.

This article focuses on the high marginal tax brackets that some taxpayers must contend with as a result of federal and state level tax reform. The top federal marginal tax rate is now 39.6 percent for taxpayers filing a joint tax return with adjusted gross income (AGI) in excess of $450,000. The new long term capital gains rate is 20 percent. The tax rate for dividend income is also 20 percent. A new Medicare tax of 3.8 percent is assessed on investment income for joint filers with AGI in excess of $250,000.

The Pease limitation on miscellaneous itemized deductions and the phase out of personal exemptions has the effect of adding an additional two percent to the marginal tax bracket. Additionally, a Medicare surcharge of 0.9 percent applies for earned income in excess of $200,000.

Some states have raised personal income taxes. The top bracket in California is now 13.3 percent of income in excess of $1 million. The top bracket for residents of New York City is 12.7 percent(8.82% State and 3.876% New York City). The top marginal bracket in New Jersey is 8.97 percent. The top bracket in Minnesota is 7.85 percent. A large cluster of states hover in the 5-7 percent range for state tax purposes.

Some states have such a high personal income tax rate that the combination of the new federal long term capital gains tax of 20 percent  along with the new Medicare tax on unearned income of 3.8 percent plus the top marginal tax rate in a particular state, approaches the top federal marginal tax rate of 39.6 percent. Consider a top marginal bracket taxpayer from California with a long term capital gains and dividend rate of at least 37.1 percent and a tax rate of  at least 58-59 percent on ordinary income!

In this game of Dodgeball, it may not be exceedingly difficult from a legal standpoint to minimize the tax impact on passive investment income and investment real estate located outside of the jurisdiction of residence.

This article is designed to analyze how the "game" is played and what it takes to avoid being "hit" by the Taxman - state or federal, in this game of Dodgeball. The article will analyze PLR 201310002 as the roadmap for how to play the game.

Non-Grantor Trusts

We need to cover a little ground before we jump into an example of the strategy. First, what is a so-called “grantor trust”? The Internal Revenue Code – Sections 671-679 provide the rules for grantor trusts. Grantor trusts have been the mainstay in advanced estate planning techniques largely since Chapter 14 (IRC Sec 2701-2704) largely paralyzed the use of “partnership freezes” and corporate reorganizations as estate freezing techniques.

Under the grantor trust rules, the trust settlor is considered the owner of trust assets for income tax purposes. As a result, all trust income and losses flow through the trust to the settlor. The trustee is able to accumulate assets within the trust without any depletion for income tax purposes. The grantor or settlor’s payment of the income tax liability is not considered an additional gift to the trust. At the same time, the trust assets are outside of the settlor’s taxable estate.

Trusts that are not taxed as grantor trusts are taxed as separate taxable entities. In general, marital trusts and most testamentary trusts are non-grantor trusts (“NGT”). Most asset protection trusts are also non-grantor trusts for income tax purposes. Unfortunately, it takes very little investment income to push a non-grantor trust into the top marginal tax bracket- $11, 950. A NGT is a trust that does not fall within any of the provisions of IRC Sec 671-679.

The essential trust provisions necessary to classify a trust as a NGT include retention of a power by the settlor to name new trust beneficiaries, or to change the interest of trust beneficiaries except as limited by a special power of appointment (ascertainable standard). The settlor’s transfer to a trust with this power renders the transfer an incomplete gift for gift tax purposes.

Income Taxation of Trust Income within a Non-Grantor

Believe or not, the legal question of a State’s right to tax trust income has been litigated a lot including the U.S. Supreme Court several times. The constitutional restraint on a State’s ability to tax trust income centers on the 14th Amendment Due Process and the Commerce Clause. Most of the States focus on these five criteria below:

(1 ) Was the trust was created by the Will of a testator who lived in the state at death?;

(2) Did the settlor of an inter vivos trust live in the State?;

(3) Is the trust administered in the State;

(4) Does one or more trustees live or do business in the State?;

(5) Does one or more beneficiaries live in the state?

Here is a brief summary for how trust income taxation works out for our key states:

(1) New York (NY) -NY will not tax a trust’s income if it has no NY trustees, no NY assets, and no NY source of income. Intangible property such as investment portfolio assets should be exempt from NY state and local income taxation in a Nevada Trust.

 (2) New Jersey (NJ)- NJ will not tax a trust’s income if it has no NJ trustees, no NJ assets, and no NJ source of income.

(3) Connecticut (CT) – CT will not tax a trust’s income if it has no CT trustees, no CT assets, and no CT source of income.

(4) California (CA) – CA taxes trust income if the trust has at least one trustee resident and one non-contingent beneficiary in CA.

(5) Massachusetts (MA) – MA will not tax a trust’s income if it has no MA trustees, no MA assets, and no MA source of income.

PLR 201310002

A. The Facts

The facts of PLR 201310002 involved the creation of a Nevada irrevocable trust. Under the provisions of the trust, the grantor established the trust for the benefit of himself and his issue. The trust had a single trustee, a corporate trustee. The terms of the trust provided that the trustee had to distribute the net income and principal as directed by the Distribution Committee of the trust. During the grantor's lifetime, the trust had three major provisions.

(1) Grantor's Consent Power - At any time, the Trustee, pursuant to the direction of a majority of the Distribution Committee members,  and with the written consent of Grantor, could distribute to Grantor or Grantor’s issue such amounts of the net income or principal as directed by the Distribution Committee

(2) Unanimous Member Power- At any time, the Trustee, pursuant to the direction of all of the Distribution Committee members, other than Grantor, could distribute to Grantor or Grantor’s issue such amounts of the net income or principal as directed by the Distribution Committee

(3) Grantor's Sole Power At any time, the Grantor, in a non-fiduciary capacity, was able but not  required to, distribute to one or more of the Grantor’s issue, such amounts of the principal as the Grantor deemed advisable to provide for the health, maintenance, support and education of Grantor’s issue. The Distribution Committee could direct that distributions be made equally or unequally among the trust beneficiaries.

The terms of the Trust provided that at all times at least two “Eligible Individuals” had to be members of the Distribution Committee. Under the terms of the trust, an “Eligible Individual” was a member of the class consisting of the adult issue of Grantor, the parent of a minor issue of Grantor, and the legal guardian of a minor issue of Grantor.

The trust terms provided that a vacancy on the Distribution Committee had to be filled by the eldest of Grantor’s adult issue other than any issue already serving as a member of the Distribution Committee, or if none of Grantor’s issue not already serving as a member of the Distribution Committee is an adult, then the legal guardian of the eldest minor issue shall serve, or if such minor issue does not have a legal guardian, then the parent of such minor issue. At all times, the Distribution committee required at least two eligible members.

Upon  the Grantor’s death, the remaining balance of  the Trust had to be distributed under the grantor's testamentary special power of appointment  to or for the benefit of any person or persons or entity or entities, other than Grantor’s estate, Grantor’s creditors, or the creditors of Grantor’s estate, as Grantor could appoint under his last will and testament.

In default of the exercise of the special power of appointment, the balance of Trust had to be distributed, per stirpes, to Grantor’s then living issue in further trust. If none of Grantor’s issue is then living, such balance had to be distributed, per stirpes, to the then living issue of Grantor’s deceased father

B. Key Rulings within PLR 201310002

The taxpayer essentially wanted three outcomes in the ruling. First, he wanted to make sure that the trust was not a grantor trust for tax purposes and that he would not be taxed on the trust's income. Secondly, the grantor wanted to ensure that the funding of the trust would not be a completed gift for gift tax purposes and lastly, that trust distributions from the trust were not taxable gifts to the either the grantor or the trust beneficiaries. The Service ruled favorably on all three matters.

(1) Non-Grantor Trust Status

Based on the facts the ruling request, the Service concluded that none of the circumstances in the trust caused the grantor to be treated as the owner of any portion of Trust under the grantor trust rules. Additionally, none of the members of the  Distribution Committee members had a power exercisable solely by himself to vest trust income or principal to himself, resulting in the Distribution Committee being treated as the owner for income tax purposes of any portion of the Trust under § 678(a).

Additionally, under the facts of the ruling, the Service did not see anything that would cause administrative controls to be considered exercisable primarily for the benefit of Grantor under § 675. The Service stated that this aspect was a question of fact dependent upon the operation of the trust and could only be evaluated at the time the tax return was reviewed.

(2) Incomplete Gift for Gift Tax Purposes.

The Service ruled that the gift was not a completed gift for gift tax purposes and that distributions by the Distribution Committee to the grantor were not completed gifts. The Grantor was considered as possessing the power to distribute income and principal to any beneficiary himself because he retained the Grantor’s Consent Power.

The retention of this power caused the transfer of property to Trust to be wholly incomplete for federal gift tax purposes. Under the consent power, the grantor retained the Grantor’s Consent Power over the income and principal of Trust.

Under § 25.2511-2(e), a donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property. The Distribution Committee members were not takers in default for purposes of § 25.2514-3(b)(2). They were merely co-holders of the power.

The Distribution Committee ceased to exist upon the death of Grantor. Under § 25.2514-3(b)(2), a co-holder of a power is only considered as having an adverse interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. In this case, the Distribution Committee ceased to exist upon Grantor’s death. The Service ruled that the Distribution Committee members did not have interests adverse to Grantor under § 25.2514-3(b)(2) and for purposes of § 25.2511-2(e).

The Grantor also retained the Grantor’s Sole Power over the principal of Trust. Under § 25.2511-2(c), a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries. In this case, the Grantor’s Sole Power gave the grantor the power to change the interests of the beneficiaries. The retention of the Grantor’s Sole Power causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes.

The grantor also retained a testamentary special  power of appointment over the property in trust allowing the grantor to appoint to any person or persons or entity or entities, other than Grantor’s estate, Grantor’s creditors, or the creditors of Grantor’s estate.

Under § 25.2511-2(b) the retention of a testamentary power to appoint the remainder of a trust is considered a retention of dominion and control over the remainder. The retention of this power causes the transfer of property to Trust to be incomplete with respect to the remainder in Trust for federal gift tax purposes.

The Distribution Committee possessed the Unanimous Member Power over income and principal. This power was not a condition precedent to Grantor’s powers. The grantor’s powers over the income and principal were presently exercisable and not subject to a condition precedent. The Grantor retained dominion and control over the income and principal of Trust until the Distribution Committee members exercised their Unanimous Member Power. Accordingly, that type of power did not cause the transfer of property to be complete for federal gift tax purposes.  Goldstein v. Commissioner, 37 T.C. 897 (1962); Estate of Goelet v. Commissioner, 51 T.C. 352 (1968)

Any distribution from the Trust to the Grantor was merely a return of Grantor’s property. The Service concluded that any distribution of property by the Distribution Committee from the Trust to the Grantor was not  a completed gift subject to federal gift tax  by any member of the Distribution Committee.

(3) No Gift Taxation for a Distribution to a Trust Beneficiary

The powers held by the Distribution Committee members under the Grantor’s Consent Power were powers that were exercisable only in conjunction with the grantor. Under § 2514(c)(3)(A), the Distribution Committee members did not possess general powers of appointment by virtue of possessing this power.

The powers held by the Distribution Committee members under the Unanimous Member Powers were not general powers of appointment. As in the example in § 25.2514-3(b)(2), the Distribution Committee members had substantial adverse interests in the property subject to this power. Accordingly, a distribution made from the trust to a beneficiary, other than Grantor, pursuant to the exercise of these powers, the Grantor’s Consent Power and the Unanimous Member Powers, were not gifts by the Distribution Committee members. Those distributions were considered gifts by Grantor.


The income tax planning possibilities under the framework of PLR 20131002 for taxpayers in high tax states is substantial. While this article did not focus on asset protection, the asset protection for the type of trust outlined in this article are substantial representing a significant additional planning benefit. The tax savings on passive investment income and real estate outside the jurisdiction of residence is readily attainable if following the roadmap outlined in this article.

  1. The contribution of property to Trust by Grantor is not a completed gift subject.
  2. Any distribution of property by the Distribution Committee from Trust to Grantor will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee.
  3. Any distribution of property by the Distribution Committee from Trust to any beneficiary of Trust, other than Grantor, will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee.



DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Gerald Nowotny, Law Office of Gerald R. Nowotny | Attorney Advertising

Written by:

Gerald Nowotny

Law Office of Gerald R. Nowotny on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.