This article is about how to lower the impact of California State income tax on capital gains using a Nevada or Wyoming Incomplete-Gift Non-Grantor Trust or NING/WING Trust. California taxes are based on income, which comes under the jurisdiction of the State of California. People in California pay some of the highest taxes in the United States with marginal state tax brackets from 1% to 13.3% in state income taxes.
California taxes all capital gains as ordinary income. A capital gain is a sale usually of stock or bonds where the sale price is higher than the purchase price. The resulting profit is a capital gain. Californians have the highest state income tax rate of any state in the U.S. If you live in California, you probably already know that. Californians have the highest capital gains tax in the United States and second highest in the world.
Outside of Denmark, California has the highest tax on capital gains. Many Californians are looking for ways to mitigate these high taxes without moving out of state. One of the ways to do this is with NING-Trust.
To avoid these high tax rates, many Californians are migrating to other states with lower tax rates. In a report issued by the IRS, over 250,000 people moved out of the state in the years 2013 and 2014. These results are the highest recorded in a decade. If people plan to leave California due to high tax rates, then they can take advantage of this by terminating their residency. By leaving the state permanently, they can do so several months before completion of a major sale in their business. But they would have to sell their family house to show authorities that their domicile has shifted. It is a tough decision to sell a family home, but the taxpayer can still take advantage of this opportunity before selling a stock or business interest.
Short of setting up a NING or WING Trust, the only real way to avoid the tax that California imposes on capital gains is to move out of the state. For example, one might change their residency to avoid tax for the sale of a business. Avoiding California's state income taxes by selling the company after a change of residency might work, but it also causes some problems. If you plan on changing residence to avoid paying taxes, plan on really moving out of California for sale and several years after to avoid fraud allegations. The state can audit your tax returns for several years after the sale of the business. Moving out of the state means that the taxpayer should not have intentions of moving back to California and should plan to make the other state their permanent residence. After selling the business, the taxpayer should not give tax authorities in California any indication of going back for years after completion of a business sale. If this seems complicated and unworkable, in most cases, it probably is.
If you cannot or do not want to move out of the state, you may be able to avoid taxes by using the strategies outlined in this article.
California State Sales Tax
If you are feeling guilty about living in California and are not paying the high capital gains imposed by the state, you can take comfort in the fact that California has the 9th highest sales tax rate. Along with the sales tax, there is a single or multiple local sales taxes, as well as special district taxes, which ranges from 0.1 percent to 1 percent. As per the statistics, the current combined sales tax in California ranges from 7.25 percent to 10.25 percent. The variation in range depends upon the location of the sale.
Californians pay local taxes, which could be in the form of business license fees, property taxes, fines, and permit fees. They also pay state income tax of up to 13.3 percent and sales tax of up to 8.25 percent.
The amount of sales tax you pay depends on the tax rate of the state or area of residence. For example, Bakersfield zip-code 93311 has a total sales tax of 8.25%. If you live in Santa Barbara, California, in the 93101-zip code, the sales tax rate is 8.75%. The highest I could find was the city of Long Beach at 10.25% sales tax.
What to Do About the Tax on Capital Gains in California
You just have two options:
- Just pay them. Keep up on your taxes and pay them on yearly basis. You can also work with someone at a firm who would help you ensure that all paperwork is properly filed and get the check out in the mail each April.
- Set up Nevada or Wyoming Incomplete-Gift Non-Grantor Trust. This is the option to avoid paying high state taxes. You will still need to pay income tax on income that you earn in California, property you own in California, and sales tax for anything you buy in California.
State Income Tax for Californians
California's state tax income tax can be up to 13.3 percent on personal income tax rates. These tax rates are imposed on the income of residents, as well as on the income of non-residents who are working in California. Even when using NIGN Trust, you will still be required to pay tax on wages or income you earn in the state of California.
What is a Non-Grantor Trust?
The major difference between a grantor trust and a non-grantor trust is that the non-grantor trust is a separate taxpayer that enables residence in a different state.
When you transfer property into a trust that you own and control, it is called a grantor trust.
A non-grantor trust is a property that has been transferred to another person or company that you no longer control. It also must be for the benefit of a third party. For example, you might transfer stock that you own to a Wyoming trust company that will hold and use the money for your grandchildren. That way, the income generated by the trust will not be taxed by the state of California, allowing the benefit to your grandchildren to be that much more.
The non-grantor can reside in Nevada or Wyoming, which has no existing state income tax. The Nevada or Wyoming Incomplete Non-Grantor Trust is a powerful tool for people who want to protect their assets from state income tax. People who have used the NING or WING tool have exceptionally increased their net rate of return on investment by eliminating the state income taxes.
By eliminating the state taxes, Californian citizens can save a huge amount of net return on investment. Not only will this tool help Californians with tackling the huge state income tax problems, but it will also help them in avoiding the need of moving out of California because of the highest tax rates. The NING has been approved by many private letter rulings by the IRS. The best part of NING Trust is that it is not taxable in California on trust income if no distributions to California beneficiaries are made.
With such a great opportunity, there is no way that it would attract many people to minimize state taxes. Therefore, certain limitations have been imposed on the WING/NING Trust. However, there are only three limitations on the NING Trust that are described below:
State of Residence
The first and foremost thing that a trustee needs is to be in a state that provides asset protection status to the trustee, such as the states of Nevada or Wyoming. If a WING/NING Trust is not created in any one of these states with such type of plans or statute, then this will allow grantors' creditors to reach the trust assets and will result in imposing state income tax on the grantor.
Furthermore, the tax will be imposed on the distributions to resident beneficiaries. The best use is long-term strategies for those who are ready to accumulate income over a specific period. NING Trust is specifically designed for them. Although the trustee will get to enjoy a tax-free income in case of annual accumulation amount, this growth can mimic an IRA. Remember to pay close attention to the laws in your state of residence as few states tax the grantors in every situation.
Type of Assets
The second factor that limits the use of NING is the intangibles owned by investors. The intangibles include but are not limited to bonds, securities, mutual funds, and stocks. For example, in case of ownership of tangible property like works of art, the state tax will be imposed and cannot be avoided. However, to avoid such insurmountable obstacles, the owner can convert the tangibles into intangibles, which are owned by NING and allows individuals to minimize state tax. Remember that intangible stocks should be avoided as they would not be appropriate for NING, and all compensation will be taxed when earned.
Control of the Trust
The third and final limitation in WING/NING is the loss of control. Even though it is true that the grantor will not be able to exercise control directly over the assets, this does not mean that the grantor will be losing all of his assets by surrendering it along with the deposition and investment. To say it in layman's terms, a grantor can become a discretionary beneficiary of assets and investments.
The WING/NING allows the grantor to create plans and design the powers in a way that allows the grantor to exercise rights over who gets what of distributions and when. This decision power allows the grantor to be involved in a more direct manner with assets and investment decisions.
A Look into Benefits of a Non-Grantor Trust
As discussed previously, the benefits of non-grantor trust are enormous and definitely help people to avoid high state tax rates. An example of the benefits of how NING can help Californian taxpayers:
- Suppose a big investor company owns shares in a corporation on a low basis. The investor deposits a minimal capital in this corporation, which let's say, is a startup tech. In a short course of time, the company grows tremendously and is approached by a number of suitors. The outcome of this all leads to the investor receiving a whopping $50 million above his basis as a payment of his shares. Now, if the shares are registered with NING, then this will only lead to federal tax on the gain, which is realized and recognized. These shares will not be affected by the California income tax and will help the investor to have more net return. If the investor did own the shares directly, then he would be paying additional state income tax that will be in the range of $6,650,000. The amount mentioned here is on the basis that the investor is in the federal income tax bracket of the maximum 39.6 percent, due to other reported income in current transactional year.
- Depending on the facts and figures shared above, it can be clearly seen that the investor will save a huge amount on the investment with NING as he is likely to pay any state taxes. There will be a federal deduction, but the investor will be free from state income taxes. Another great advantage that will benefit the investor from non-grantor trust like the Nevada Incomplete Non-Grantor Trust is that the taxpayer is likely to hit the maximum taxpayer bracket. Even if the taxpayer is already in the 39.6 percent bracket, due to other income sources, it is likely to be a factor included in the rate differential between trusts and individuals.
- Now, let us look at a case and assume a situation where our investor accumulates a net $6 million savings on his sales of stock after different offsets. These savings are kept with the trust for another 15 years. Now, let's take into account the annual return and a four percent net of federal tax. With the help of non-grantor trust like NING, the investor saves $10,805,661 on the original investment of $6 million. So, we conclude that without the non-grantor trust, this amount would have been lost from taxpayers or other beneficiaries.
As discussed in detail, there are many unique opportunities for Californians to use WING/NING to avoid state income taxes. Remember that careful analysis and planning is required, even for the undistributed income within the trust that may be taxed at a higher federal income tax rate and can affect the overall tax saving. The greater advantages and significance of NING is a win-win opportunity. But, it must be noted that Wyoming/Nevada Incomplete Non-Grantor (NING) Trust is not appropriate for everyone. Every individual should carefully analyze and plan to conclude whether NING is appropriate. NING must only be considered as a part of the overall estate and tax planning strategy if found appropriate after thorough analysis and planning.