This tactic to avoid income taxes without moving to Florida could surge thanks to a 'silver tsunami'

• Uber-rich business owners in high-tax states can save on income taxes without moving.
• Instead of selling their businesses outright, they put their stock in a trust in a tax-haven state.
• Incomplete non-grantor trusts come with strings attached but can pay off nicely.

Top earners continue to flock to states with little to no income tax such as Florida and Texas. It's an especially smart move if you're about to sell a business. As for rich entrepreneurs who aren't ready to make a move, they can still save on taxes with the right lawyer.

By creating a special kind of trust, business owners can take advantage of the loose tax laws of other states. Instead of selling a business outright, they transfer their shares to an incomplete non-grantor trust set up in a tax-haven state such as Nevada. When the shares are sold, the trust collects the proceeds without paying any state income or capital-gains taxes. The trust assets grow free of those taxes and are shielded from creditors.

Dan Griffith of Huntington Bank expects ING trusts will surge in popularity with dealmaking on the rebound coinciding with a "silver tsunami."

"You've got baby-boomer business owners who need to transition, and you also have a ton of capital on the sidelines looking for transactions," Griffith, Huntington's director of wealth strategy, said. "With more deals comes more need for tax-saving strategies."

Investors can also benefit from putting their portfolios in ING trusts because that allows the dividends to grow free of state taxes. ING trusts are powerful tax-avoidance tools, so much so that New York and California have enacted laws to render them useless for state residents. California closed the loophole in 2023, estimating it would increase tax revenue by $30 million that year and $17 million each following year.

Each state also has its own provisions to navigate, which makes setting up INGs cumbersome. However, Bank of America's Timothy Herbst said it could still be worth it in states without sky-high income-tax rates.

"That trust can grow conceivably without any state income tax," the wealth-strategy executive said. "That's a significant savings even in a state like North Carolina at 4.5%. It's not necessarily a huge income tax, but you look at a very large portfolio growing over decades, that can be real significant savings."

Here is how ING trusts work

ING trusts come in different flavors. Nevada and Delaware are popular states for domiciling ING trusts, where they're referred to as "NINGs" and "DINGs," respectively. However, Wyoming and South Dakota are also options as they do not tax trust income or capital gains and protect trust assets from creditors.

The person who creates the trust, otherwise known as the settlor, does not have to reside in that state, but the trust should be administered by a third party who does.

Here's an example of how an ING trust can work.

Consider a business owner in Oregon looking to sell a business worth $50 million that was worth barely $1 million when it was founded. Oregon taxes income and capital gains at 9.9% for top earners. If the owner sold their shares outright, they would be on the hook for $4.8 million in taxes. Instead, they transfer their shares to an ING trust in Nevada. When the business is sold, the trust is spared those income taxes. The remainder, after federal capital-gains taxes, can be invested and grow free of state and local taxes.

ING trusts are still subject to federal capital gains taxes, but the ultrawealthy users of INGs would likely be subject to that burden anyway. For a centimillionaire, it's not hard to reach the top rate of 37%, which applies to incomes above $578,126.

"These are superrich people," Bob Lord, a senior advisor on tax policy for the Patriotic Millionaires, said. "They're still taking in enough to get to the 37% bracket."

Furthermore, INGs can be used to take advantage of a tax perk for early shareholders that exempts at least $10 million in profits from the federal capital-gains tax. Steve Oshins, a Nevada lawyer, said founders could double their exemption by setting up an ING trust.

"This trust can serve as a second taxpayer so that the individual can get a second $10 million exemption," he said. "This can apply even if they don't live in a state with a state income tax."

For the ING trust to pass muster with state authorities, there should be multiple beneficiaries in addition to the settlor and their spouse. Since beneficiaries do have to pay state income taxes — if applicable — when they receive distributions. For this reason, lawyers advise that clients take as few distributions as possible and let the assets grow in the trust for their children or future generations.

"It is usually better that the client knows that distributions won't be coming back to him or her or to their spouse," Herbst said. "If they did need those distributions, then it probably is not going to be the right strategy."

That said, sometimes taking a distribution makes sense if there is financial need or the client has moved to a low-tax state since setting up the ING trust, Oshins said.

"You just have to look at each fact pattern on its own and make the right decision," he said.

Buyer beware

1. ING trusts can't be used to avoid state taxes on salaries or rental income.

ING trusts cannot be used to defer income taxes on salaries or income from tangible assets in the state. That income, referred to as source income, is subject to state taxes.

For instance, Griffith said, an Ohio resident cannot avoid state or local taxes on income from rental properties in the state even if they transfer ownership of the properties to an ING trust in South Dakota.

For clients in states with aggressive tax authorities, Griffith recommends they step away from their business' day-to-day operations and collect a minimal salary before transferring their interests to the ING trust.

"What you really need to do is become essentially just a shareholder, be, as a business owner, somebody who says, 'I am just receiving dividends from this company. I own C-corp stock,'" he said. "In many states, that becomes non-source income."

2. Setting up an ING trust is like threading a needle.

These trusts have to be structured carefully to avoid triggering estate taxes of as much as 40% while keeping the income-tax advantages. In addition to navigating the laws in the home state and the tax-haven state, the settlor has to retain certain rights and relinquish others. For instance, the settlor can't have the ability to compel distributions but should have the right to name beneficiaries at death.

"It's inherently complicated," Griffith said. "You've got to have a fairly sizable transaction to make the juice worth the squeeze."

3. The trust has to be set up well before the business is sold.

It is easier for a state tax authority to pursue income from the sale of a business if it is done shortly after the ING trust is established. Griffith recommends at least a year's delay, but it is the biggest challenge for clients, he said.

"They're like, 'Oh, I don't want to fund the trust until we know we're going to sell.'" he said. "You have to do it in advance. And if you do, those are the ones that I've seen that have been really successful."

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