This will be a very short post with a few simple lessons I have shared before:
- Fast tax advice, is like fast fashion. A waste! It’s all too often a big mistake with serious repercussions.
- If something sounds too good to be true, it is.
So, if you have not heard of it yet, today’s post will introduce you to the “Non-Grantor Irrevocable Complex Discretionary Spendthrift Trust” (NGICDST). Yes, it’s a mouthful, sounds complicated and might be all the more alluring for the uninformed who may naively believe that the “overly complex” somehow means it is smart (even if they don’t really know what it is all about because they can’t understand the words).
The NGICDST is a marketed trust structure which makes a huge mistake in interpreting the US tax law – specifically, Section 643 of the US Internal Revenue Code. This convenient misinterpretation magically makes taxable income on capital gains and other investment income completely disappear! That’s right – no tax.
The NGICDST is being marketed by lawyers, accountants, enrolled agents and unlicensed tax advisors in a number of places, including social media platforms such as TikTok and YouTube or on business websites complete with slides that make for a convincing presentation.
It’s Simple – Taxable Income Cannot and Does Not Magically Disappear
Unsurprisingly, the Internal Revenue Service (IRS) discovered the promotional material and on August 9, issued a Memorandum explaining why it does not work (Voila! it’s not magic after all).
The IRS explanation is detailed and might not be understood by the layman or tax pro’s who are unfamiliar with the complexity of trust taxation issues. Cutting through to the chase, I will explain it in very simple terms: Taxable income does not magically disappear with trusts. Someone must pay tax on it. Who that “someone” is will depend on factors such as how the trust was structured and whether the trustee has made distributions of income to the beneficiaries. Make no mistake, the founder of the trust, the trust itself, and/or the beneficiaries will be paying tax. Always. It’s that simple.
“Reasonable Cause”? I’m Laughing! 🤣🤣🤣
Invested in a NGICDST? Sometimes, tax penalties can be forgiven or at least abated by the IRS if the taxpayer can demonstrate he or she had “reasonable cause” for the tax return errors. Penalty forgiveness or abatement based on “reasonable cause” is not easy to get. Choose your US tax advisor very carefully. If he or she lacks the US tax experience you may need, reliance on the tax advice may not be considered “reasonable,” leading to plenty of penalties.
Treasury Regulation 1.6664-4(c) provides substantial guidance on how the IRS and courts will evaluate such a “reasonable cause” claim when made by a taxpayer. The Regulations state, for example, that “reliance may not be reasonable or in good faith if the taxpayer knew, or reasonably should have known, that the advisor lacked knowledge in the relevant aspects of Federal tax law.” The courts look at various factors and especially examine whether the adviser was a competent professional having sufficient expertise so as to justify the taxpayer’s claimed reliance. TikTok?
If you have made the mistake and been duped into a NGICDST, you need good tax help before the IRS catches up with you.
More Information
Finally, if you want to learn more about trusts, especially foreign trusts, my blog posts will be of interest. Check out some of them here, here and here. They demonstrate the complexity involved with trusts and should give you an idea why “TikTok” tax advice can be a very dangerous thing!
Posted August 31, 2023
All the US tax information you need, every week –
Named by Forbes, Top 100 Must-Follow Tax Twitter Accounts @VLJeker
Named by Bloomberg, Tax Professionals to Follow on LinkedIn
Subscribe to Virginia – US Tax Talk to receive my weekly US tax blog posts in your inbox. My blog specializes in foreign and US international tax issues.
You can access my papers on the Social Science Research Network (SSRN) at https://ssrn.com/author=2779920
Photo by BlenderTimer
Virginia - US TAX TALK 
Great article. I was pitched this several times by people outside the US. If I were to search, I think I have a much shorter and more easily digested explanation of why it doesn’t work.
Richard LeVine
Of Counsel
Wealth Planning & Tax
t +1 203 974 0317 c +1 203 376 8798 f +1 203 285 1617
withersworldwide.comhttp://withersworldwide.com| my profile<www.withersworldwide.com/en-gb/people/richard-levine>
Secretary: Karolyn DeGrand t +1 203 974 0379
Withers Bergman LLP
157 Church Street, 12th Floor, New Haven, Connecticut 06510-2100
[cid:image001.jpg@01D9DB8C.B2644380]https://www.withersworldwide.com/en-gb/insight/what-would-you-do-in-a-crisis?utm_source=email+signature+banner+2&utm_medium=email&utm_campaign=crisis+management&utm_id=crisis+management
LikeLike
Hi Richard… maybe I am showing my age, but TikTok and other social media platforms would be the LAST place I would ever dream of looking for tax advice!!!
LikeLike
Virginia:
Here is my refutation:
Here is the refutation of their argument:
Section 1 (e) imposes income tax on the taxable income of every trust.
Section 61(a)(3) defines income to include income from all sources, including gains from dealing in property
Section 641(a)(1) states that the tax under Section 1 (e) applies to all income earned by a trust, including income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated
Section 651(a) allows a deduction to the trust for income distributed to a beneficiary
Section 651(b) limits the Section 651(a) deduction to the “distributable net income” of the trust (DNI)
Section 652(a) taxes the beneficiary if they receive a distribution of DNI
Section 643(a)(3) allows a fiduciary to exclude capital gains from DNI
Here is how all those rules fit together:
Suppose a trust starts the year with $100 of cash, and during the year it received $100 of interest income and $100 of capital gain, and then distributes $200 to a beneficiary
If the trustee allocates the capital gain to DNI, then the trust’s DNI is $200
The entire $200 distribution to the beneficiary is taxable to the beneficiary under Section 652
The trust’s income for the year is then $0, because it has $200 of income and gets a $200 deduction under Section 651(a)
If the trustee allocates the capital gain to corpus / principal, then the trust’s DNI is $100
Only $100 of the distribution is taxable to the beneficiary, because there was only $100 of DNI
The trust has taxable income of $100, because it has $200 of income and only gets a $100 deduction under Section 651(a) because the deduction is limited to DNI under Section 652(b)
So, by allocating capital gain between income and principal, the trustee can control whether the tax is paid by the beneficiary or by the trust. But the allocation of capital gain between income and principal does not reduce the total amount of income subject to tax. If the trust earned $200 of net income, someone is going to pay tax on $200. The only question is how much the beneficiary pays and how much the trust pays.
Or to put it another way, when you allocate capital gain to principal and not to income, you are not reducing the trust’s taxable income. What you are reducing is the maximum amount that the beneficiary has to pay tax on, but also reducing the maximum amount that the trust can deduct by making distributions. If the capital gain is not part of DNI, then the trust does not get a deduction for distributing those dollars. Without a distribution deduction, the trust remains taxable on the gain.
I know that this 643 argument is floating around all over the West Coast. It is simply wrong. And the “contractual trust” argument is bogus as shown by the materials I sent you earlier this week. Let me know if you need more from me. Be well.
Richard LeVine
Of Counsel
Wealth Planning & Tax
t +1 203 974 0317 c +1 203 376 8798 f +1 203 285 1617
withersworldwide.comhttp://withersworldwide.com| my profile<www.withersworldwide.com/en-gb/people/richard-levine>
Secretary: Karolyn DeGrand t +1 203 974 0379
Withers Bergman LLP
157 Church Street, 12th Floor, New Haven, Connecticut 06510-2100
[cid:image001.jpg@01D9DB8D.23E6A4D0]https://www.withersworldwide.com/en-gb/insight/what-would-you-do-in-a-crisis?utm_source=email+signature+banner+2&utm_medium=email&utm_campaign=crisis+management&utm_id=crisis+management
LikeLike
Thanks as always Richard, for adding so much to this post. I hope everyone reads your comment as it is a great explanation.
LikeLike