Summary:
- Key Point: A Nevada Incomplete Gift Non-Grantor Trust (“NING”) may offer state income tax and estate planning benefits in some states, but current California law generally eliminates the traditional NING income-tax benefit for California resident grantors.
- Why it matters: Business owners relying on NINGs before a sale may still face California tax, and improper timing or transfer structure can leave the seller responsible under assignment-of-income principles.
- Action point: California business owners should begin planning before a sale is binding and evaluate alternatives such as domicile planning, completed-gift trusts, charitable planning, installment sales, QSBS planning, rollovers, or other transaction structures.
A business owner preparing to sell a closely held business or another highly appreciated asset may face substantial state income tax in addition to federal capital-gains tax. In certain states, a Nevada Incomplete Gift Non-Grantor Trust (“NING”) may reduce state income tax while also providing long-term asset-management and estate-planning benefits.
For California residents, however, current law has largely eliminated the traditional state income-tax benefits of a NING. California owners anticipating a substantial sale should evaluate other planning strategies before the transaction becomes binding or practically certain.
What Is a NING Trust?
A NING is an irrevocable trust established and administered under Nevada law. It is generally designed with three features:
- Separate taxpayer status. As a non-grantor trust, the NING is treated as a taxpayer separate from the person who creates it.
- Incomplete-gift treatment. The transfer to the NING generally is not a completed gift for federal gift-tax purposes and ordinarily does not use the grantor’s gift-tax exemption.
- Nevada administration. The trust is administered in Nevada, which has no individual state income tax and offers favorable trust laws.
If the grantor’s home state respects this arrangement and the trust recognizes income that is not sourced to another state, income retained by the trust may not be subject to state income tax.
A NING does not eliminate federal income tax. The trust remains subject to federal tax, and non-grantor trusts reach the highest federal income-tax bracket at relatively low levels of income.
How May a NING Apply to a Business Sale?
Assume a business owner expects a $10 million gain and resides in a state with an effective income-tax rate of approximately 10%. The resulting state tax could approach $1 million, depending on that state’s rates, deductions, sourcing rules, and treatment of the transaction.
In a state that recognizes NING planning, the owner may transfer the business interest to a properly structured NING before the sale becomes binding or practically certain. The trust may then be treated as the owner and seller of the interest. If the gain is not sourced to the owner’s home state, the NING may recognize the gain without state income tax.
The trust must genuinely acquire the business interest and assume its economic benefits and risks. Simply directing sale proceeds to a trust after arranging the transaction will not shift the tax.
Why Is Nevada Used?
Nevada does not impose an individual state income tax and has well-developed trust laws. Its statutes provide flexibility in trust administration, modification, and decanting—the process of transferring assets from an existing trust into a new trust with different terms. Certain Nevada trusts may also continue for up to 365 years, allowing assets to be managed for multiple generations.
Nevada’s laws may provide asset-protection benefits when a trust is properly established and administered. Those protections are not absolute and may be limited by existing creditor claims, fraudulent-transfer laws, retained powers, or the laws of another state with a stronger connection to the parties or assets.
Why a Traditional NING Generally Does Not Work for California Residents
For taxable years beginning on or after January 1, 2023, California generally requires a California resident grantor to report the income of an incomplete gift non-grantor trust. As a result, using Nevada law, appointing a Nevada trustee, or administering the trust in Nevada ordinarily will not prevent California from taxing the NING’s income.
California also may tax California-source income regardless of where the trust, trustee, grantor, or beneficiaries are located. This may include income or gain connected to California real property, a business operating in California, or other California-based activities.
California provides a limited exception for certain trust income distributed to a qualifying charitable organization within the required period. The exception applies only when the grantor has a genuine charitable objective and permanently transfers the applicable funds to charity.
A traditional NING therefore generally is not an effective California income-tax strategy for a California resident. A viable alternative must change a substantive part of the plan, such as the owner’s domicile, whether the transfer is a completed gift, the charitable use of the property, or the structure of the sale.
Potential Alternatives for California Owners
No single strategy is a direct substitute for a NING. The appropriate alternative depends on the type of asset, the source of the gain, the status of the sale, the owner’s need for the proceeds, and the owner’s willingness to relinquish control or make a charitable transfer.
- Genuine Change of Domicile
An owner may establish bona fide domicile in a state without individual income tax before the sale becomes binding or the right to the proceeds becomes fixed.
California determines residency based on all relevant facts, including the locations of the owner’s principal home, spouse and family, business activities, personal property, professional relationships, financial accounts, and social ties. California also considers the amount of time spent inside and outside the state. A nominal or temporary move shortly before a major sale may receive heightened scrutiny.
Even after a valid move, California may continue to tax California-source income. Gain attributable to California real property or certain California business activities may remain taxable. Residency and income sourcing must therefore be analyzed separately.
- Completed-Gift Non-Grantor Trust
An owner may make a completed and irrevocable gift of the business interest to a non-grantor trust for a spouse, children, or other descendants. Because the gift is complete, California’s rule specifically addressing incomplete gift trusts may not apply in the same manner.
The owner must relinquish personal ownership and unrestricted access to the transferred property. The gift may use federal gift-tax exemption and ordinarily should be reported on a federal gift-tax return supported by a qualified appraisal.
California may still tax the trust based on California-source income or the residence and rights of its trustees and beneficiaries. This approach is generally most appropriate when the owner is willing to transfer the business interest and resulting proceeds permanently for the beneficiaries.
- Charitable Remainder Trust
A Charitable Remainder Trust (“CRT”) may be suitable for an owner who has charitable objectives and wants to retain an income stream. Before the sale becomes binding or practically certain, the owner transfers the appreciated interest to the CRT. The CRT may then sell the interest, reinvest the proceeds, and make payments to the owner or other recipients for life or a specified term. The remaining assets ultimately pass to charity.
A CRT generally defers rather than eliminates tax. Taxable gain is recognized over time as payments are made, and a California resident ordinarily remains subject to California tax on taxable distributions. The owner must permanently dedicate the required remainder interest to charity.
- Installment Sale
An installment sale may spread the seller’s gain over the years in which payments are received. This can defer tax and improve cash-flow management.
A later move from California does not necessarily prevent California from taxing deferred gain arising from a sale completed while the seller was a resident. The arrangement must also address buyer credit risk, interest, depreciation recapture, related-party restrictions, and income sourcing.
- Qualified Small Business Stock
If the company is a qualifying C corporation and its shares satisfy Internal Revenue Code § 1202, some or all of the gain may be excluded from federal income tax. Eligibility depends on detailed requirements involving original issuance, the holding period, the corporation’s gross assets, and the nature of its business.
California generally does not conform to the federal exclusion, but the federal savings may still be significant. In some cases, qualifying stock may be transferred to separate completed-gift trusts before the sale becomes fixed. This approach, sometimes called “QSBS stacking,” requires genuine completed gifts, independent trusts, and careful review of federal anti-abuse rules.
Internal Revenue Code § 1045 may also permit federal gain deferral when proceeds from the sale of qualifying stock are timely reinvested in replacement qualified small business stock.
- Equity Rollover or Tax-Deferred Reorganization
A buyer may allow the seller to exchange or “roll over” part of the seller’s ownership into the acquiring entity. Alternatively, part of the transaction may qualify as a tax-deferred reorganization. If properly structured, these approaches may defer gain until the replacement ownership interest is later sold.
Cash, promissory notes, assumed liabilities, or other nonqualifying consideration may still create current taxable gain. These strategies generally defer rather than permanently eliminate California tax.
- Transaction Structure and Purchase-Price Allocation
Even when California tax cannot be eliminated, the form of the transaction may improve the overall result. The parties may compare an equity sale, asset sale, installment sale, partial rollover, or qualifying reorganization.
The allocation of the purchase price among goodwill, equipment, inventory, noncompetition obligations, consulting services, and compensation can materially affect the character and source of the seller’s income. The allocation must reflect the transaction’s economic substance and generally should be reported consistently by the buyer and seller.
Additional Tax and Administrative Considerations
Potential state tax savings must be weighed against federal income and transfer taxes, trust tax rates, trustee fees, appraisal costs, and ongoing administrative expenses. The federal net investment income tax also may apply.
The residence and powers of the trustees, and the residence and rights of the beneficiaries, can affect state taxation. Using Nevada law or a Nevada trustee does not, by itself, prevent another state from taxing the trust.
A transfer also must comply with the business’s governing documents, loan covenants, securities restrictions, buy-sell provisions, and proposed sale documents. Required consents should be obtained, and the transfer must be properly reflected in the company’s records.
Timing Is Critical
Pre-sale planning should begin before negotiations materially advance. Once the seller has accepted an enforceable offer, finalized material terms, signed a binding agreement, or otherwise acquired a fixed right to receive the proceeds, many strategies may no longer shift the resulting gain.
Under the assignment-of-income doctrine, transferring an asset after the right to income has become fixed may leave the original owner responsible for the tax. The critical point may occur before closing and, depending on the circumstances, before execution of the definitive purchase agreement. A letter of intent, required approvals, remaining contingencies, and the recipient’s ability to reject or change the transaction all may be relevant.
Conclusion
A properly structured NING may still provide state income-tax and estate-planning benefits for residents of states that recognize incomplete gift non-grantor trusts. For California residents, however, current law generally attributes the NING’s income to the grantor. Nevada governing law, administration, or trusteeship ordinarily will not change that result.
California owners may instead consider a genuine change of domicile, a completed gift to a non-grantor trust, charitable planning, an installment sale, qualified small business stock planning, an equity rollover, or a tax-deferred reorganization.
No strategy permits a California resident to eliminate California tax while retaining unrestricted ownership, control, and access to all sale proceeds. The appropriate plan depends on the source and character of the gain, the owner’s objectives, and the stage of the transaction. Planning should begin well before a letter of intent or definitive sale agreement is signed.
Leech Tishman has extensive experience advising business owners and families on estate planning, pre-sale planning, and tax-sensitive wealth transfer strategies. Our team is prepared to help California business owners evaluate alternatives to traditional NING planning and coordinate pre-sale planning before a significant transaction becomes binding. For assistance or additional information, please contact Stephen Kirschenbaum, Partner in Leech Tishman’s Trusts & Estates Practice Group.