Domestic ING Trusts: A Way to Avoid State Tax on Capital Gains?

Across the United States, planning often labeled “NING,” “DING,” or similar acronyms refers to a domestic, irrevocable, incomplete‑gift, non‑grantor trust (ING trust) sited in a chosen state so the trust—not the grantor—bears federal income tax on trust income and gains. From a federal perspective, these alternatives are all variations on the same core structure: a domestic non‑grantor trust that uses the trust taxation rules (DNI, distribution deductions, capital‑gains allocation, 65‑day election, etc.). The choice of situs (Nevada, Delaware, South Dakota, Wyoming, and others) primarily affects state law administration and state tax, but the federal rules below govern how all such ING trusts operate for income tax, regardless of state. A trust (or estate) is a separate taxpayer; it computes taxable income generally like an individual, subject to special rules for deductions and distributions, and beneficiaries are taxed on the share of distributable net income (DNI) carried out to them. See IRS Instructions for Form 1041 (U.S. Income Tax Return for Estates and Trusts) at https://www.irs.gov/instructions/i1041 and the form at https://www.irs.gov/forms-pubs/about-form-1041.

Federal Design Features Common to All Domestic ING Trusts

• Non‑grantor status is the linchpin. The governing instrument must avoid powers/interests that cause the grantor to be treated as the owner under sections 673–677 (e.g., revocation, reversionary interests within statutory limits, control over beneficial enjoyment, or income that can be used for the grantor or spouse). If the grantor is treated as the owner, the trust becomes a grantor trust and the grantor’s return includes all trust income. See Internal Revenue Code (IRC) §§ 671, 674, 675, 676, 677 (e.g., https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section671&num=0&edition=prelim and similar for adjacent sections).

• Beneficiary ownership must be avoided unless intended. If any beneficiary holds a power exercisable solely by themselves to vest corpus or income in themselves, that beneficiary can be treated as the owner under § 678, changing who is taxed on the trust’s income. See IRC § 678 IRC § 678 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section678&num=0&edition=prelim.

• Capital gains are typically retained and taxed at the trust level. By default, capital gains allocated to corpus and not paid/credited/required to be distributed in the taxable year are excluded from DNI, so they are taxed to the trust rather than being carried out to beneficiaries. If the governing instrument or applicable law allocates gains to income and they are paid/credited/required to be distributed, gains can be included in DNI and taxed to beneficiaries. See IRC § 643(a)(3) IRC § 643(a)(3) at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section643&num=0&edition=prelim.

• DNI governs the income distribution deduction and beneficiary inclusion. A trust’s deduction for amounts paid or required to be distributed is limited by DNI; beneficiaries include their share of DNI in gross income. Distributions within the first 65 days of the following year can be treated as having been made on the last day of the prior year if the trustee makes a timely election, allowing post‑year‑end matching of distributions to DNI. See IRC § 663(b) IRC § 663(b) at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section663&num=0&edition=prelim and Treas. Reg. § 1.663(b)-1 Treas. Reg. § 1.663(b)-1 at the eCFR (https://www.ecfr.gov/current/title-26/part-1/section-1.663(b)-1).

• In‑kind distribution basis mechanics and annual election. When property (not cash) is distributed, the beneficiary’s basis is generally the trust’s adjusted basis, adjusted for any gain recognized by the trust on the distribution if an election is made. A trust may elect to recognize gain on all in‑kind distributions made during the taxable year, which can be used strategically (e.g., basis planning before or after a sale). See IRC § 643(e) IRC § 643(e) at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section643&num=0&edition=prelim.

• Accumulation distributions in domestic trusts. For qualified domestic trusts, accumulation distributions are computed without regard to undistributed net income under § 665(c), eliminating the classic “throwback” effect that historically penalized accumulation distributions. This simplifies multi‑year planning for domestic non‑grantor trusts. See IRC § 665(c) IRC § 665(c) at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section665&num=0&edition=prelim and Treas. Reg. § 1.665(b)-1A Treas. Reg. § 1.665(b)-1A (throwback computation rules) at the eCFR (https://www.ecfr.gov/current/title-26/part-1/section-1.665(b)-1A).

• Reporting and pass‑through framework. Trusts file Form 1041 and issue Schedules K‑1 to beneficiaries. The trust/estate rules determine how items are taxed at the trust level versus carried out to beneficiaries and how those items retain character upon distribution. See IRS Instructions for Form 1041 at https://www.irs.gov/instructions/i1041.

State‑Situs Comparison (Federal Lens)
Because federal income tax treatment of domestic ING trusts is uniform nationwide, “alternatives” among states (e.g., NING vs. DING vs. SING, etc.) differ primarily in two dimensions outside the federal code:

• Administration and fiduciary law (directed trusts, decanting, modification processes, creditor protection, trustee powers/standards).

• State tax regime (whether a state imposes income tax on resident/nonresident trusts and under what nexus/beneficiary presence rules).

Federal law does not dictate those state‑specific outcomes, so the choice of situs does not change the federal mechanics described above. Regardless of whether a trust is sited in Nevada, Delaware, South Dakota, or elsewhere, the trust must (1) avoid grantor‑trust status under §§ 673–677, (2) be mindful of § 678 powers held by beneficiaries, and (3) operate under the DNI/§ 643 framework for capital gains and distributions. See IRC §§ 671–678 at https://uscode.house.gov/browse/prelim@title26/subtitleA/chapter1/subchapterJ/partI and IRS Instructions for Form 1041 at https://www.irs.gov/instructions/i1041.

Practical ING Alternatives and When They Fit

• ESBT for S corporation shareholders. An electing small business trust (ESBT) is a permitted S corporation shareholder and is treated as two separate trusts for income tax: the “S portion” and the “non‑S portion.” The S portion is taxed at the highest trust rate and does not use the regular DNI pass‑through, while the non‑S portion uses ordinary trust rules. For owners of S stock contemplating a sale or holding S interests in trust, an ESBT may be preferable to a standard ING if S eligibility and special tax computation provide better results. See IRC § 641(c) IRC § 641(c) (ESBT rules) at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section641&num=0&edition=prelim and Treas. Reg. § 1.641(c)-1 Treas. Reg. § 1.641(c)-1 at the eCFR (https://www.ecfr.gov/current/title-26/part-1/section-1.641(c)-1).

• QSST for single‑beneficiary S shareholders. A qualified subchapter S trust (QSST) is another permitted S shareholder trust in which the income beneficiary is treated as the owner. A QSST can be useful where the goal is to pass S corporation income directly to one beneficiary for personal tax treatment rather than keep it inside a non‑grantor trust. Selection between ESBT and QSST depends on whether trust‑level taxation (ESBT) or beneficiary‑level taxation (QSST) better aligns with the planning goals. QSST guidance appears in IRS materials and Treas. Reg. § 1.1361 Treas. Reg. § 1.1361‑1 at the eCFR (e.g., https://www.ecfr.gov/current/title-26/part-1/section-1.1361-1).

• § 645 election for a qualified revocable trust post‑death. A qualified revocable trust can elect to be taxed as part of its related estate during the election period. When a founder dies, this election can consolidate estate and trust items into one Form 1041 for administration/timing and may simplify cash flow and DNI planning during the estate administration window. See IRC § 645 IRC § 645 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section645&num=0&edition=prelim and Treas. Reg. § 1.645-1 Treas. Reg. § 1.645-1 at the eCFR (https://www.ecfr.gov/current/title-26/part-1/section-1.645-1).

• Alaska Native Settlement Trust (ANST). For Alaska Native corporations transferring assets to Settlement Trusts, § 646 provides a specialized regime: a lower tax rate on trust taxable income, special distribution ordering rules, and irrevocable election mechanics. While niche, it is a bona fide alternative for eligible sponsors seeking trust‑level income management distinct from standard ING trusts. See IRC § 646 IRC § 646 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section646&num=0&edition=prelim and IRS Form 1041‑N (for electing settlement trusts) at https://www.irs.gov/forms-pubs/about-form-1041-n.

• Foreign non‑grantor trust alternative (with caution). Some consider foreign non‑grantor trusts to achieve different state tax results, but U.S. federal rules impose additional reporting (e.g., § 6048) and different DNI computation for foreign trusts (e.g., inclusion of worldwide capital gains) and may treat loans/use of property to U.S. persons as distributions. In addition, U.S. beneficiaries of foreign non‑grantor trusts face UNI/accumulation tax mechanics and interest charges. These complexities distinguish foreign trusts from domestic ING alternatives and generally require heightened compliance. See IRC § 6048 IRC § 6048 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section6048&num=0&edition=prelim and IRS Publication/Guidance on foreign trust reporting (e.g., Form 3520 instructions at https://www.irs.gov/instructions/i3520 and Form 3520‑A at https://www.irs.gov/instructions/i3520a). For foreign trust DNI differences, see Treas. Reg. § 1.643(a)-6 Treas. Reg. § 1.643(a)-6 at the eCFR (https://www.ecfr.gov/current/title-26/part-1/section-1.643(a)-6). The IRS LB&I Process Unit overview of foreign non‑grantor trust beneficiary taxation is at https://www.irs.gov/pub/fatca/int_practice_units/taxation-beneficiary-foreign-non-grantor-trust-r.pdf.

Company Sale Scenarios in Any ING‑Situs State (Federal Mechanics)

• C corporation shares sold by a domestic non‑grantor trust. If the trust avoids grantor status under §§ 673–677, the trust is the taxpayer on the sale. By default, capital gains are allocated to corpus and taxed at the trust level unless the governing instrument/local law causes them to be included in DNI and distributed. The trustee can use the 65‑day election to optimize the timing of distributions relative to DNI. See IRC §§ 671, 643(a)(3), 663(b) at the U.S. Code links above and Treas. Reg. § 1.663(b)-1 Treas. Reg. § 1.663(b)-1 at the eCFR.

• Sale by ESBT/QSST. For S corporation stock, confirm the trust qualifies as ESBT or QSST before the sale. ESBT’s S portion is taxed under special rules (often at the highest marginal trust rate) and does not use the usual DNI pass‑through; the non‑S portion uses standard DNI. A QSST pushes S income to the beneficiary as the deemed owner. Selection turns on the desired tax locus (trust vs. beneficiary) and compliance requirements. See IRC § 641(c) IRC § 641(c) and Treas. Reg. § 1.641(c)-1 Treas. Reg. § 1.641(c)-1 at the eCFR.

• In‑kind distribution before or after sale. The trust can distribute appreciated shares to beneficiaries. If no § 643(e)(3) election is made, beneficiaries take the trust’s basis; if the election is made, the trust recognizes gain and beneficiaries receive fair market value basis for that year’s distributions, which can be beneficial before a subsequent sale by the beneficiary. See IRC § 643(e) IRC § 643(e).

Checklist: ING “Alternatives” That Matter Federally in Any State

• Eliminate grantor‑trust triggers in the instrument and administration to ensure non‑grantor status. See IRC §§ 673–677.

• Confirm no beneficiary holds § 678 powers unless intended (which would alter who is taxed). See IRC § 678 IRC § 678.

• Draft/account to control capital gain inclusion/exclusion from DNI and plan distributions with the 65‑day rule. See IRC § 643(a)(3) IRC § 643(a)(3); IRC § 663(b) IRC § 663(b); Treas. Reg. § 1.663(b)-1. Treas. Reg. § 1.663(b)-1.

• Consider § 643(e)(3) recognition election for in‑kind distributions where basis planning would improve outcomes. See IRC § 643(e) IRC § 643(e).

• For S corporations, evaluate ESBT vs. QSST depending on whether trust‑level or beneficiary‑level taxation is preferable. See IRC § 641(c) IRC § 641(c); Treas. Reg. § 1.641(c)-1. Treas. Reg. § 1.641(c)-1.

• Understand that qualified domestic trusts generally avoid throwback/UNI complications under § 665(c), simplifying long‑term accumulation planning. See IRC § 665(c) IRC § 665(c); Treas. Reg. § 1.665(b)-1A. Treas. Reg. § 1.665(b)-1A.

Conclusions
From a federal tax vantage point, “NING alternatives” across states are all domestic incomplete‑gift non‑grantor trusts operating under the same federal rules for trust taxation, distributions, and capital gains. Differences among states are primarily matters of state trust law and state income tax policy—not federal tax mechanics. No matter the situs, effective planning hinges on maintaining non‑grantor status (avoiding §§ 673–677 triggers and § 678 beneficiary ownership), mastering the DNI framework (including capital gains treatment under § 643(a)(3) and the 65‑day election), and deploying specialized options like ESBT/QSST for S stock or § 643(e)(3) basis planning. Trusts report and pass through income under Form 1041 rules; beneficiaries include their share of DNI; and trustees can time and characterize distributions to optimize outcomes consistently under federal law. See IRS Instructions for Form 1041 at https://www.irs.gov/instructions/i1041, IRC § 643 IRC § 643 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section643&num=0&edition=prelim, and IRC § 663 IRC § 663 at https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section663&num=0&edition=prelim.

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.