Investments and Alaska Native Settlement Trusts: Navigating the Tax Landscape
Nick Whitmore, KPMG LLP
In recent years, Alaska Native Corporations (ANCs) have increasingly turned to Alaska Native Settlement Trusts (ANSTs) as a strategic tax planning tool. Transferring assets from the ANC to an ANST can provide direct financial advantages to their shareholders. That said, the tax implications of such contributions, especially when involving non-cash assets, require careful consideration. This blog post explores the tax considerations associated with contributing cash and non-cash assets from an ANC to an ANST.
ANSTs have been around for 25 years, but only since the beginning of 2018, with the passage of the Tax Cut and Jobs Act (the Act), have they taken a more central role in tax planning. The Act introduced significant changes to the tax treatment of contributions to ANSTs. The most notable change is that the sponsoring ANC’s may now elect to deduct (with certain limitations) the lesser of the fair market value (FMV) or the tax basis of the contributed asset. The ANST, in turn, generally reports as income the amount of the deduction taken by the ANC. This change creates a tax advantage, as the ANC receives a deduction at the enacted corporate tax rate – currently 21% – while the ANST recognizes the receipt of the income at the lowest individual tax rate – currently 10%. This rate arbitrage can result in substantial tax savings and makes the contribution of assets an attractive tax planning tool in an ANC’s arsenal.
Understanding the tax relationship between the Corporation and Trust
At its core, the tax relationship between an ANC and its ANST is straightforward. The simplest form involves the ANC contributing cash to the ANST, which then distributes these funds to the ANST’s beneficiaries. This direct approach provides immediate financial benefits to shareholders by minimizing taxes paid by the ANC and ANST and is relatively easy to manage from a tax perspective. ANCs often add a ‘gross-up’ amount when contributions are made to ensure the ANST has sufficient cash flow to pay their 10% tax on contributions while maintaining the desired level of distributions to the ANST’s beneficiaries. The cash contributions, as previously mentioned, are deductible by the ANC, limited to the ANC’s taxable income (e.g. this deduction may not create or add to a tax loss). Due to these limitations, ANCs that operate with tax losses or have significant NOL carryforwards may not see a current tax benefit. In that scenario, because the trust will pay 10% on the cash received by the corporation, the ANC and ANST may find a situation where they are paying more combined current taxes.
The Complexity of Non-Cash Asset Contributions
The tax relationship becomes more intricate when ANCs consider contributing non-cash assets, such as real estate, stocks, or other investments, to the trust. This strategy can offer additional benefits beyond just the tax rate arbitrage, including the potential for asset appreciation within the trust taxed at more favorable rates and deferred tax payments.
When non-cash contributions are involved, the ANC deducts the lesser of FMV or tax basis from its taxable income. The ANC must determine the fair market value of the assets at the time of contribution, which can be challenging and may require professional appraisals. The ANST, on the other hand, now has the option to delay paying the 10% tax on the contributed non-cash asset until it ultimately sells the asset to a third party. The reason the law allows this deferral is to allow the ANST to manage cash flow – we all know you can’t give the IRS 10% of a building to pay your taxes! Having this deferral election elevates alleviates the necessity of liquidating non-cash assets to pay the required taxes on the contribution.
Investment portfolios are often targeted for contributions to the trust due to even more favorable rate arbitrage. In addition to the deferral of tax on the original contribution, long term capital gains and qualified dividends are taxed at a preferential rate of 0% within the trust – compared to a 21% tax rate if the investment was held by the ANC. This provides additional tax savings to the beneficiaries of the ANST. While an attractive tax planning tool, contributions of investment portfolios often come with a significant administrative burden to track. Investment portfolios have a natural turnover rate, and each underlying stock needs to be tracked so when assets that were originally contributed to the trust are sold, the appropriate deferred tax can be paid. Many investment accounts are structured to reinvest dividends and capital gain distributions, which can make it more difficult to isolate an originally contributed stock, its sale, and its tax basis. Having an investment advisor and tax accountant working together with the ANST can help plan for and alleviate some of this burden.
Navigating Uncharted Waters
It’s important to note that the tax code framework governing these contributions is relatively new and largely untested by the IRS and courts. This uncertainty means that ANCs must tread carefully and seek expert advice to navigate potential pitfalls when contributing non-cash assets to ANSTs. Engaging with tax professionals who specialize in ANSTs can help ANCs optimize their contributions while minimizing tax risks. As with all things tax, there is the general rule, followed by pages of exceptions, not all of which have been addressed here. Always consult your own tax advisor before implementing any tax strategies.
Conclusion: A Strategic Approach to Shareholder Benefits
ANSTs present a versatile mechanism for ANCs to deliver shareholder benefits while strategically managing corporate tax liabilities. By contributing non-cash assets, ANCs can enhance the well-being of their communities and shareholders. However, the complexities of tax planning in this context necessitate a thorough understanding of the larger tax picture and careful execution. As the regulatory environment evolves, ANCs must remain vigilant and proactive in their approach to leveraging settlement trusts for the benefit of their shareholders.
About the Author
Nick Whitmore is a life-long Alaskan and currently a Tax Managing Director at KPMG, serving the Alaska market for 14 years. He is also a licensed CPA in the state of Alaska and a member of both the American Institute for CPA’s and the Alaska Society of CPA’s. Having spent his entire career in Anchorage, Nick has developed a deep understanding of Alaska Native Corporations unique tax status, Alaska Native Settlement Trusts, and the tax rules and advantages offered to ANC’s.
Nick specializes in accounting for income taxes, tax planning and consulting, and tax compliance matters for ANCs, ensuring these organizations navigate complex tax landscapes effectively. Since the passage of the 2017 Tax Cut and Jobs Act, Nick has worked with companies across the state to plan and implement tax strategies using new provisions in the tax law that allows ANC’s to obtain tax benefits for contributions to a Settlement Trust.
A proud alum of the University of Alaska Anchorage, Nick holds a bachelor’s degree in accounting and an associate’s degree in Logistic Operations and Supply Chain Management.
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