Take-away: The intentional use of an incomplete gift trust is becoming a topic to cover with individuals, particularly when asset protection trusts are a possibility, or the more sophisticated intentional non-grantor (ING) trust is considered to accumulate income, state income tax-free.

Background: In recent months (or years) emphasis has been placed upon encouraging individuals to make completed  lifetime gifts, to remove assets and their future appreciation from the individual donor’s taxable estate. Even more emphasis has been placed on lifetime gifts in the last couple of years in order for an individual to use their currently large ($12.06 million) applicable exemption amount before that exemption is cut in half beginning 2026. However, there are occasions and reasons why a donor may wish to make an incomplete gift as part of their estate plan.

No Applicable Exemption Amount: One obvious situation would be when the donor has already consumed his/her applicable exemption amount, such that a federal gift tax would have to be paid on the donor’s lifetime transfer.

Asset Protection Trust: Another situation might be when the donor funds an asset protection trust (APT) like Michigan’s Qualified Dispositions in Trust, because the donor will otherwise consume his/her federal gift tax exemption when they fund the APT and that used exemption will be wasted if the assets are later distributed back to the donor from the APT

Income Accumulation Trusts: In states which impose a high income tax on accumulated trust income, often an incomplete gift is made to the irrevocable trust in order to avoid the imposition of state income taxes on that accumulated trust income, like an intentional dynasty trust. These trusts are sometimes called ING trusts, or the popular Delaware Incomplete Non-Grantor Trust, or DING trust. With increasing income tax rates many high earning individuals are now exploring creative ways to shift taxable income to non-grantor trusts, e.g. to avoid higher Medicare contribution tax rates; an incomplete gift trust enables them to shift some income away from themselves while avoiding making a taxable gift.

Incomplete Gifts: To make lifetime transfers incomplete gifts, the donor must retain some power to name new trust beneficiaries or to change the interests of the beneficiaries.  [Treasury Regulation 25.2511-2 and IRC 674(b)(3).] Three excerpts from the Regulations that define an incomplete gift follow:

“But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined. For example, if a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and  the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift….However, if the exercise of the trustee’s power in favor of the grantor is limited by a fixed or ascertainable standard, enforceable by or on behalf of the grantor, then the gift is incomplete to the extent of the ascertainable value of any rights thus retained by the grantor.” [Treasury Regulation 25.2511-2(b).]

“A gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard. Thus, if an estate for life is transferred but, by an exercise of a power, the estate may be terminated or cut down by the donor to one of less value, and without restriction upon the extent to which the estate may be so cut down, the transfer constitutes an incomplete gift. If in this example, the power was confined to the right to cut down the estate for life to one for a term of five years, the certainty of an estate for not less than that term results in a gift to the extent complete.” [Treasury Regulation 25.2511-2(c).]

“A gift is not considered incomplete, however, merely because the donor reserves the power to change the manner or time of enjoyment .Thus, the creation of a trust the income of which is to be paid annually to the donee for a period of years, the corpus being distributable to him at the end of the period, and the power reserved by the donor being limited to a right to require that, instead of the income being so payable, it should be accumulated and distributed with the corpus to the done at the termination of the period, constitutes a completed gift.” [Treasury Regulation 25.2511-2(d).]

Powers of Appointment: An incomplete gift is often accomplished by the donor retaining a lifetime or testamentary limited power of appointment.  A gift is incomplete if the donor retains a testamentary power of appointment. [Treasury Regulation 25.2511-2(b).] However, the IRS’s Chief Counsel’s has concluded that a testamentary power of appointment standing alone was not sufficient to make a gift to a trust incomplete, despite the language of the just cited Regulation. [Chief Counsel Memorandum 201208026.] Accordingly, in order to ensure an incomplete gift, the donor should retain both a lifetime and testamentary limited power of appointment over the trust property.] Lifetime limited powers of appointment that are limited by an ascertainable standard could also possibly cause completed gift problems.[ Treasury Regulation 25.2514-1(c)(2).]

Asset Protection Trusts: In an asset protection trust (APT) state, it is a challenge to create an incomplete gift, non-grantor trust. In order for such a trust of which the donor is also a beneficiary to be a non-grantor  trust, the consent of an adverse party is necessary with respect to making discretionary distributions to the donor. [IRC 677(a)(1).] Often the trust instrument will provide for a distribution committee comprised of adverse parties to the donor-beneficiary, and that committee will make all discretionary distribution decisions. The consent of the adverse parties is required in order for the donor, or the donor’s spouse, to receive distributions from the trust or for the trustee to accumulate income in the trust, subject to the donor’s retained lifetime and/or testamentary powers of appointment. (The donor’s retained powers of appointment make the donor’s transfer to the APT an incomplete gift for federal gift tax purposes.)

Veto Power: If the donor’s transfer is to an asset protection trust (APT), the retention of both the lifetime and testamentary limited power of appointment will not cause the APT to be classified as a grantor trust for income tax reporting  purposes. [Treasury Regulation 1.674(b)-1(b)(5)(i), for a lifetime power of appointment that is limited by a reasonably definite standard, and IRC 674(b)(3), for a testamentary power of appointment.] The donor could also ensure that his/her transfer to the APT is incomplete by retaining, in a non-fiduciary capacity the right to veto the distribution committee’s distribution decision; this veto power makes the transfer into the APT an incomplete gift and a non-grantor trust without subjecting the trust’s assets to the donor’s creditors. [IRC 674(a); Treasury Regulation 25.2511-2(c).]

DINGs: There is a bit of uncertainty with regard to DING-type trusts these days. Back in 2005 to 2007, the IRS issued a series of Private Letter Rulings (PLRs) with regard to  the structure of Delaware APTs, in which the IRS concluded that a donor can create a non-grantor APT for federal income tax purposes, fund the trust with contributions that are not considered taxable gifts for federal gift tax purposes, and still retain the right to receive discretionary distributions of trust income and trust principal. These older PLRs concluded that: (i) a distribution from the APT to a beneficiary other than the donor would be a completed gift by the donor; and (ii) the distribution committee members had substantial adverse interests to each other for purposes of the federal gift tax rules [IRC 2514] and therefore these members did not possess general powers of appointment over the APT corpus. Accordingly, distributions from the APT would not be subject to gift tax with respect to the distribution committee members. [PLR 200715005.] The IRS then promptly  indicated that it was reconsidering these PLRs. [IRS News Release IR-2007-127.] Later, in 2013 and 2014, the IRS issued more favorable PLRs with respect to DINGs, i.e. an incomplete gift to the trust was made by the donor-beneficiary; distribution committee decisions do not result in completed gifts made by members of the distribution committee, i.e. they are not considered to hold general powers of appointment over the APT’s assets. Thus,  these latter PLR’s provided a roadmap to structure a non-grantor APT, transfers to which are incomplete gifts by the donor. Unfortunately, starting in 2021, DINGs began to appear on the IRS’s ‘no-ruling’ list, on which the IRS will no longer issue PLRs. [Revenue Procedure 2021-3, continued in Revenue Procedure 2022-3, Section 5 (.01)(15) and (18).] Specifically, the IRS declared that it will not rule on: (i) whether the beneficiaries who are members of the DING’s distribution committee hold general powers of appointment over the trust corpus; or (ii) whether the donor’s transfer of assets to a non-grantor trust is an incomplete gift.

QPRTs: The concept of an incomplete gift also appears in the statute that authorizes qualified personal residence trusts, or QPRTs.  “ (A) In general, this subsection shall not apply to any transfer-(i) if such transfer is an incomplete gift, (ii)if such transfer involves the transfer of an interest in trust all the property in which consists of a residence to be used as a personal residence by persons holding term interests in such trust, or (iii) to the extent that regulations provide that such transfer is not inconsistent with the purposes of this section. (B) Incomplete gift for purposes of subparagraph (A), the term ‘incomplete gift’ means any transfer which would not be treated as a gift whether or not consideration was received for such transfer.” [IRC 2702(a)(3).]

Reserved Powers with Others: Even if the donor’s reserved power can only be exercised in conjunction with another person, as long as that other person does not have a ‘substantial adverse interest in the disposition of the transferred property or the income therefrom’, the gift is still considered incomplete. [Treasury Regulation 25.2511-2(e).]

Estate Taxes: With an incomplete gift to a non-grantor trust, the trust corpus will be included in the donor’s taxable estate, but those assets will also receive an income tax basis adjustment at the donor’s death, or the estate tax alternate valuation date, which can assist with long-term income tax planning.

Conclusion: In a world where we strongly advocate making lifetime gifts to reduce a donor’s exposure to federal estate taxes, or to use their large applicable exemption amount while it exists, there are still occasions where an incomplete gift may be warranted.  A gift is considered complete only when the donor has given up complete dominion and control and has not reserved sufficient power to change the disposition of the transferred property. Reserved powers by the donor that result in an incomplete gift include the ability to name new beneficiaries or change the interests among the beneficiaries, unless the power held by the donor is held not individually but as a fiduciary and it is limited in scope. An incomplete gift is often intentionally created in APTs and INGs with the retention of limited power of appointment (lifetime and testamentary.) For those individuals who have exhausted their applicable exemption amount and who still face future federal estate tax liability, an incomplete gift is something to discuss with them.