Strategies for Investors, Tax Professionals, and Estate Planners
Introduction: Purpose and Definition of Non-Grantor Trusts
A non-grantor trust is a legal entity separate from its creator (the grantor). Unlike grantor trusts, the non-grantor trust pays its own income taxes and is not considered transparent for tax purposes. This distinction opens the door to several unique tax advantages, making non-grantor trusts a valuable tool for tax professionals, investors, and estate planners seeking to optimize tax outcomes for clients and beneficiaries.
Qualified Small Business Stock Strategies
Non-grantor trusts can play a pivotal role in maximizing the exclusion of gain from the sale of qualified small business stock (QSBS) under Section 1202 of the Internal Revenue Code. Each non-grantor trust is considered a separate taxpayer, allowing for the possibility of “stacking” Section 1202 exclusions. By creating multiple non-grantor trusts, planners can multiply the amount of gain excluded from federal income tax, subject to statutory limits. This strategy is especially effective for families or investors with substantial holdings in qualified small businesses.
Section 199A Benefits: Qualified Business Income Deduction
The Section 199A deduction allows eligible taxpayers to deduct up to 20% of qualified business income (QBI) from certain pass-through entities. Non-grantor trusts can also qualify for this deduction if they receive QBI from businesses. Moreover, by distributing income to beneficiaries or retaining income within the trust, planners can manage taxable income to optimize Section 199A benefits. This flexibility can help avoid phase-outs and maximize deductions across multiple taxpayers.
SALT and Charitable Deduction Advantages
State and local tax (SALT) deductions are limited for individuals, but non-grantor trusts can provide additional opportunities. Each trust is subject to its own SALT deduction limit, allowing for increased aggregate deductions when multiple trusts are used. Non-grantor trusts also enable separate charitable deductions, which can be strategically planned to maximize tax benefits for families or philanthropic investors. By allocating assets and making charitable contributions through non-grantor trusts, planners can enhance deduction opportunities beyond what is available to individual taxpayers.
State Income Tax Avoidance: Trust Situs Selection
One of the most powerful advantages of non-grantor trusts is the ability to minimize or avoid state income tax by carefully selecting the trust’s situs (location). By establishing the trust in a state with no income tax or more favorable tax laws and by meeting requirements to avoid taxation in the grantor’s home state, planners can significantly reduce state tax liability. This technique is especially valuable for high-net-worth individuals and families who reside in high-tax states but wish to preserve wealth for future generations.
Conclusion: Key Tax Advantages and Strategic Considerations
Non-grantor trusts offer a robust toolkit for tax optimization. They allow for stacking QSBS exclusions, maximizing Section 199A deductions, enhancing SALT and charitable deductions, and strategically avoiding state income taxes. Tax professionals, investors, and estate planners should consider these trusts when developing comprehensive strategies for wealth management and tax reduction. While the rules governing non-grantor trusts are complex, the potential benefits make them an essential part of advanced tax planning.
