Financial advisors looking to reduce the tax bills of wealthy clients living in high-tax states should consider incomplete non-grantor trusts.

INGs provide asset protection, but if they are established in no-income tax states such as Delaware or Nevada, they can avoid the grantor’s home state tax.

“This is a strategy that is definitely not well understood or well known by the average trusts and estate attorney,” says advisor Adam Katz at Merrill Lynch's Private Banking and Investment Group in New York.

High-net-worth clients with a portfolio or business that they think will appreciate significantly could be candidates for INGs, if they can’t move to a lower tax state.

“INGs are best-suited for someone who doesn’t have flexibility to re-domicile their life, but this is a way of re-domiciling ownership to a state that that has no income tax,” Katz says.

A typical strategy would be for a client to place the shares of a business that they hope to sell for a profit into an ING trust. When the sale happens, the proceeds go into the trust.

“A couple of years later, the distribution committee can decide to distribute all the proceeds back to the grantor and terminate the trust in effect, and the grantor has gotten all the money without having paid state income tax,” says attorney Gideon Rothschild, who heads the trusts and estates practices at Moses & Singer in New York and is also a certified public accountant.

There are some pitfalls, however.

Last year, New York started prohibiting residents from using INGs to avoid home state tax, and other states could follow.

An ING must have a distribution committee whose members are considered “adverse” to the grantor. That means that the members, who basically act as trustees, must also be beneficiaries.

Some clients may be wary of placing so much faith in their beneficiaries.

“Let’s say the kids are adult beneficiaries, and they’ll be the ones making up the distribution committee,” Rothschild says. “Now you’ll have to worry whether the kids will gang up against you and never give you a dollar of distribution from this trust, which makes some people a little uncomfortable.”

Also, INGs are time-consuming and expensive to set up.

“There are a lot of moving pieces,” says Rothschild, and if they aren’t set up correctly, they can trigger unwanted gift taxes.

It isn’t a good idea to try to set one up too close to a sale, either.

“If you try to do this and then sell the business in five months, the [Internal Revenue Service] is likely to look at that pretty negatively,” Katz says.

Advisors and lawyers who work with INGs recommend getting a private-letter ruling from the IRS approving the set-up in advance.

“Some people feel like they can just piggy-back off of other private-letter rulings,” Katz says. “But if they’re looking to save 60 grand in legal and IRS costs versus savings millions of dollars in taxes, I would encourage them to go through the private-letter rulings.”

Paul Hechinger is a New York-based freelance writer.