California, home to one of the largest collections of multi-millionaires on Earth, has chosen to crack down on the use of trusts in other US states as a way of stemming revenue outflow. An advisor who warned about the move earlier this year returns to say that the state is making a mistake it will regret.
California’s decision to press ahead with the way incomplete gift non-grantor trusts or ING trusts are treated for state income tax purposes means that even more residents will leave California, shrinking the state’s tax base and depressing revenue in the medium term, an advisor warns.
Earlier this year, California governor Gavin Newsom proposed to impose state income tax on ING trusts. The changes were enacted on 21 July and, controversially, take effect retroactively from 1 January 2023. This contrasts with the approach of New York in 2014 when those affected were granted a “tax holiday” to adjust their affairs and plan for the tax.
Family Wealth Report spoke earlier in 2023 to Venable LLP partner, Kevin Ghassomian, about the issue. And now that California has pulled the trigger, he is even more convinced that Sacramento’s lawmakers are making a mistake.
“ING trusts with income in 2023 will certainly be impacted, but there’s nothing in the new legislation that incentivises ING trusts with income accumulated in prior tax years to be shut down,” he said.
California has not historically taxed trusts based on the residence of a settlor but has done so based on where the trust’s fiduciaries and beneficiaries reside, he said.
By making the change retroactive, California has prejudiced the ability of its residents to engage in legitimate tax and trust planning.
“California could have followed New York’s approach by enacting a temporary reprieve for residents with existing ING trusts, but it didn’t and as a result there will be continued gamesmanship with INGs and various trust alternatives. Even worse, more and more residents are instead opting to leave the state and, of those leaving, many are business owners, who are taking jobs with them,” Ghassomian continued.
Before the law was changed, the income of a non-resident ING trust was subject to California income tax only if the trust has California source income, a fiduciary residing in California, or a non-contingent California resident beneficiary. Now, however, ING trusts settled by a California resident, regardless of what state they are established, will be vulnerable, even those set up in Nevada or South Dakota.
The crackdown on the use of out-of-state non-grantor trusts by the government in Sacramento also sheds light on how the state, which levies some the highest taxes in the US, is seeking to stem outflows of revenue and plug budget deficits.
Private wealth advisors, like Ghassomian, warn that such moves may accelerate a recent trend of net migration from California to states such as Texas, Florida, Tennessee, and Nevada. According to the US Census Bureau (report: San Francisco Chronicle, 22 December 2022), California’s population fell by 114,000 people from about 39,143,000 in 2021 to 39,029,000 in 2022. Firms such as Charles Schwab, Hewlett Packard and Tesla have relocated their HQs from the state. The plight of the state – still home to many HNW individuals – has become a standard theme of American political debate. California’s Bay Area has 692 resident centi-millionaires (those with $100 million or more), followed by Los Angeles with 504 such persons (source: Henley & Partners).
(An earlier version of this article appeared on sister news service Family Wealth Report. The issue is specific in some ways to the US, but it does shed light on how states, including those within federal ones, seek to tackle revenue outflows and whether such methods cause more harm than good in the long run. Comments as always are welcome. Email email@example.com)