Robert W. Wood is a tax lawyer representing clients worldwide at Wood LLP in San Francisco. He is the author of numerous tax books, often writing taxes for Forbes, tax notes and other publications.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. This discussion should not be regarded as legal advice.
The United States Internal Revenue Service (IRS) treats Bitcoin and other cryptos as property. That means each property transfer can trigger taxes, with a tax hit to both the recipient and the transferor. A key question at transfer time is market value. Some cryptoinvestors put crypto into legal entities like corporations, LLCs, or partnerships. Another avenue is a crypto-asset trust.
In North Carolina Dept. of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, the U.S. Unanimously, the Supreme Court said a state could not tax out-of-state residents on trust income without minimal contacts. We’ll come back to that case, but should note that trusts can be taxed in several different ways, depending on their type. There are living trusts people usually use for estate planning, but living trusts aren’t taxed separately.
Crypto and living trusts
So, if you transfer Bitcoin to your living trust, it usually isn’t a taxable transfer, since your living trust isn’t really a separate taxpayer. So you still report the gain or loss on a later sale on your personal tax return. There are also nongrantor trusts where the transferee is not taxed. These are taxed separately, and a separate tax return must be filed.
Trust tax rules can be complex, but the trust itself pays taxes. Another distribution tax may apply to beneficiaries. But leaving aside distribution issues, where does the trust pay taxes? It depends. Some trusts are foreign, so they’re set up outside the U.S. Such rules are complex, but if you’re a U.S. person, you shouldn’t assume you can avoid U.S. taxes with a foreign trust.
Still, your trust may pay the lower corporate tax rate of 21% rather than your individual tax rate.
What about government taxes?
That’s where things get interesting. Some trusts are set up with an eye on reducing or avoiding state taxes — say, if you are in California and don’t want to move to Nevada before you sell your Bitcoin. You want to cut the sting of California’s high 13.3% state tax, but you aren’t willing to move — at least, not yet. You could consider setting up a new type of trust in Nevada or Delaware.
A “NING” is a Nevada Incomplete Gift Non-Grantor Trust. A “DING” is its Delaware sibling. There is even a “WING” in Wyoming. The usual grantor trust for estate planning doesn’t help, since the grantor must include the trust income on his/her own tax return. The donor makes an incomplete gift to the trust with a Nevada or Delaware Incomplete Gift Non-Grantor Trust and has an independent trustee.
The idea is to involve the grantor, but not the owner. New York State changed its law to make the grantor taxable, no matter what, but the jury is still out on these trusts in California and other states. Some marketers of NING and DING trusts offer them as alternatives or adjuncts to a physical move.
The idea is for the income and gain in the NING or DING trust not to be taxed until distributed, when the distributees will hopefully no longer be in the high tax state. The trustee must not be high-tax resident. Parents frequently fund irrevocable trusts for children and may not want the trust to make distributions for years, removing future appreciation from the parents’ estates. Tax-deferred compounding can yield impressive results, even if only state tax is being sidestepped.
For tax purposes, most trusts are considered taxable where the trustee is situated. A common answer for NING and DING trusts is an institutional trust company. Also, trust and distribution committees should not be residents. Facts, papers, and details matter, and states like California may well push back. However, doesn’t the Supreme Court’s recent North Carolina case help?
North Carolina case
The court ruled that North Carolina’s tax statute asserting jurisdiction on a foreign trust based solely on the residence of a beneficiary was too broad. But it is still constitutional for a state to tax based on the residence of the trustee or the site of the trust’s administration. Who forms the trust also matters. In the North Carolina case, the trust was formed by the taxpayer’s father, and he was a resident of New York.
The taxpayer in the case was the daughter, not the trustee, and had no control over the trust. In the years involved in the case, she received no distributions from the trust. That made it a pretty compelling case for the Supreme Court to tell North Carolina it couldn’t tax her.
In contrast, many NING/DING trusts are formed by the person in the high tax state trying to avoid state tax — a person in California, for example. And then there’s the distribution question, as some NING/DING trusts expect the settlor to receive distributions. Administration can also be touchy, as some NING/DING trusts include the settlor/beneficiary as a member of a distribution committee that controls trust distributions.
Therefore, depending on the NING/DING trust facts, the Supreme Court’s ruling seems pretty limited. In fact, the case is limited to the handful of states that use beneficiary residence as the sole factor for determining the state’s taxing jurisdiction. The court said its ruling should not affect states that consider recipient residence as only one of several factors determining their tax jurisdiction. Interestingly, California is one of five states identified in the case that establishes jurisdiction based entirely on the beneficiary’s residence.
Even here, though, the opinion carves out California’s tax statute as an issue to resolve at a later date. California law only allows the state to assert jurisdiction based solely on the beneficiary residence when the beneficiary’s interest is not contingent (such as not subject to the discretion of a trustee). The North Carolina case involved a trustee who had discretion to control distributions, or to not make distributions at all.
So, will your trust work to shield you and your beneficiaries from state tax? Depending on the right facts, creative trusts may be worth trying, but be careful. You don’t want to be low-hanging fruit for the high tax state to attack.
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