The ABCs of DINGs

A recent article published to our Trusts 101 library discusses qualified small business stock (“QSBS”) planning opportunities under the One Big Beautiful Bill Act, including the use of QSBS “stacking” involving non-grantor trusts. As mentioned in the article, for various reasons, the non-grantor trusts used in QSBS stacking often take the form of an incomplete gift, non-grantor trust (known as an “ING trust,” or a “DING trust” when established and administered in Delaware). 

But what exactly is a DING trust? This article is intended to provide a basic overview of the DING trust, including its general structure, the benefits and common uses of DING trusts and potential complications that can arise during planning and/or administration.

Structure

By its nature, the DING trust is structured as a self-settled asset protection trust under 12 Del. C. §3570 et seq., also known as the Delaware Qualified Dispositions in Trust Act (the “Act”). To qualify under the Act, a trust must: (i) expressly incorporate the laws of the state of Delaware to govern the validity, construction and administration of the trust; (ii) be irrevocable; and (iii) expressly provide that the interest of a transferor or other beneficiary may not be transferred, assigned, pledged, or mortgaged, voluntarily or involuntarily, before the trustee actually distributes the property to the beneficiary.

Governing law and place of administration

A DING trust needs to have a “qualified Trustee” under 12 Del. C. §3570(8), meaning a resident of Delaware or a corporate trustee authorized to act as such in the State of Delaware and subject to proper regulatory supervision, who materially participates in the administration of the trust. A Delaware resident corporate trustee, like Commonwealth Trust Company, meets this qualification. The term “materially participates” is not expressly defined but some statutory examples of trustee activities that would demonstrate evidence of material participation include (i) maintaining or arranging for the custody of some or all of the trust property, (ii) maintaining records for the trust, and (iii) preparing or arranging for the preparation of fiduciary income tax returns for the trust. Notably, the trust can also have other fiduciaries (e.g. Direction Advisers) who reside outside of the state and actively participate in the administration of the trust. 

Beneficiaries

As a self-settled asset protection trust, a DING trust includes the Settlor among the class of discretionary beneficiaries of the trust. The trust can include the Settlor’s spouse, Settlor’s descendants or any other parties as discretionary beneficiaries. The trust will also need to include the members of the trust’s Distribution Committee (more on this below) as discretionary beneficiaries.

Incomplete gift status

Any gifts to a properly drafted DING trust are considered incomplete gifts for federal gift tax purposes. This is typically accomplished by drafting the trust so the Settlor holds both lifetime and testamentary limited powers of appointment over the trust property. The Settlor is also often given a power to veto distributions to other beneficiaries.

Non-grantor trust status

The DING trust is structured to avoid grantor trust treatment for the Settlor under §671-679 of the Internal Revenue Code. This is primarily addressed by using a Distribution Committee composed of adverse parties who hold certain powers under the trust instrument, most notably the power of discretionary distribution decisions.

An “adverse party” is defined in §672(a) as a person “having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power.” Thus, a DING trust must be carefully drafted to ensure parties who have “a substantial beneficial interest” (i.e., beneficiaries) have the power to approve or consent to discretionary decisions regarding the distribution of trust income and principal, including distributions to the Settlor or Settlor’s Spouse.

In addition, if the trust meets the requirements of the Act and is afforded creditor protection, it can avoid grantor trust treatment under the IRS Treasury Regulation §1.677(a)-1(d), which qualifies a trust as a grantor trust if a Settlor’s creditors can reach trust assets to satisfy a debt of the Settlor.

Potential Benefits and Common Uses

Control and potential access to trust assets

Some Settlors who establish an irrevocable trust naturally hesitate when it comes time to fund the trust and they are required to give up full control over the assets they contribute or give up their rights over such property. A DING trust may alleviate some of that discomfort, potentially giving the Settlor retained control over trust investments and disposition of trust assets, and inclusion as a discretionary beneficiary of the trust. 

When a DING trust is structured so the Delaware trustee is a directed trustee for investment purposes, the Settlor can often hold the role of an investment adviser within the trust, with discretion over certain investment decisions and the power to direct the trustee with respect to those decisions.

As mentioned, the Settlor is included among the class of discretionary beneficiaries of the trust, and while the Settlor should fund the DING trust with assets she or he does not anticipate needing, and does not retain a right to receive a distribution from the trust upon demand, the Settlor retains the ability to receive distributions from the trust, though the decision to make the distribution remains at the discretion of the Trustee (as directed by the Distribution Committee). Additionally, the Settlor maintains some control over the disposition of trust assets through their retained lifetime and testamentary powers of appointment and veto power over distributions to other beneficiaries. 

Asset protection

A self-settled asset protection trust will contain a spendthrift provision that protects the trust assets from creditors. If a creditor wishes to file a claim against the property contributed to such trust, they are limited by Delaware’s statute of limitations. For a claim arising prior to the creation of the trust, the creditor must bring such a claim within four years after the creation of the trust (or within one year after the creditor discovered or should have discovered the trust). For a claim arising after the creation of the trust, the creditor must bring the claim within four years after the trust’s creation. In both cases, the creditor must also establish, by clear and convincing evidence, that the creation and funding of the trust was fraudulent.

State income tax savings

If a DING trust is funded with assets that are later sold, a Settlor can reap some tremendous state income tax savings. Under 30 Del. C. §1636(a), Delaware does not impose a state income tax on trust income or capital gains to the extent such income or gains are set aside for non-Delaware beneficiaries. Thus, if the trust does not have another connection to a high-tax jurisdiction (for example, a Direction Adviser who is a resident of a state that would impose state income tax based on the residency of the Direction Adviser), the trust may be able to avoid paying any state income tax on the sale of the assets contributed to the DING trust. These savings can grow substantially when the assets contributed and sold have a low tax basis.

Basis step up

Because the DING trust is structured as an incomplete gift trust, the trust assets will generally receive a step up in basis upon Settlor’s death, which is another benefit to the trust beneficiaries.

Potential Complications

Proper structuring

DING trusts are complex and one should engage an experienced attorney to draft the trust instrument and help with planning. For example, the Distribution Committee should be structured carefully to avoid any one member of the committee from holding a power deemed to be a general power of appointment and causing the trust to be includable in their estate.

Following the terms of the trust instrument

As with all trusts, care should be taken to ensure the terms of the trust instrument are followed. A professional corporate trustee can be extremely helpful in this regard by ensuring the trust is properly administered (e.g., proper approvals or directions are obtained from appropriate parties for trust transactions) and that the trust records are documented accordingly.

Timing of transactions

As noted above, one of the major benefits of a DING trust is the potentially substantial state income tax savings incurred on the sale of low basis assets that would otherwise be subject to state income tax but for the fact that the assets are held in the DING trust. The trust can be drafted and structured perfectly, but that alone is not sufficient. An experienced attorney should also be engaged to assist with any planning surrounding the funding of the trust and the sale of any assets in the trust. If the DING trust is established solely for the purpose of avoiding state income taxation and the sale of that asset occurs shortly after the assets are funded to the trust, the state that could have taxed the sale may bring an action questioning the legitimacy of the trust and the transaction. 

Specific state and IRS considerations

Taxing authorities in New York and California have enacted legislation to target the use of DING trusts (and other ING trusts) negating the tax benefits of DING trusts for Settlors residing in those states.

The IRS has issued numerous private letter rulings (PLRs) and Chief Counsel Memoranda regarding incomplete-gift, non-grantor trusts over the past 15-20 years. Beginning in 2021, the IRS has taken the position that it will not issue PLRs on certain key issues relating to DING trusts.

Conclusion

As detailed above, DING trusts can provide substantial benefits to individuals in certain situations. However, due to their complex nature and the amount of planning needed to effectively utilize a DING trust, one should consult with an experienced attorney to guide the formation and planning of such a trust. One should also consider using an experienced trustee to ensure the terms of the trust are properly followed while continuing to provide smooth administration of the trust. Involving professionals can help to avoid some of the obvious, and not-so-obvious, pitfalls involved during the planning and administration phases; however, one must also be aware of the uncertainty surrounding incomplete-gift, non-grantor trusts caused by developments in state tax laws as they explore more potential sources of tax revenue and potential changes in the IRS’s position regarding the taxation of DING trusts.