Using an Intentionally Defective Grantor Trust

Sep 17, 2023 | Estate Administration, Estate Planning, Special Needs Trust, Trust

Using an Intentionally Defective Grantor Trust


What is an IDGT?


An intentionally defective grantor trust (IDGT) is a tool used by estate-planning attorneys to freeze assets to reduce the grantor’s estate tax.


How does it work?


As a trust, the IDGT is allowed to receive income from some trust assets. Meanwhile, the grantor still pays income tax on any income generated, but no estate taxes would be owed upon the grantor’s death.


What makes an IDGT defective?


The “intentional defect” is a flaw left in the trust on purpose to preserve the grantor’s requirement to pay tax on the trust’s income. Because the grantor continues to pay income tax, the beneficiaries pay no estate tax when the grantor dies.


How is an IDGT created?


The grantor may either gift or sell assets to the IDGT. However, a gifted asset will likely trigger a tax. Therefore, the grantor typically sells assets to the trust. The sale is done in exchange for a promissory note from the trust. This is like a mortgage but is called an installment note. The duration of these loans is usually for a significant length of time.

The sale of the assets to the IDGT does not trigger a capital gains tax and thus is ideal for eliminating assets that have increased significantly in value from the grantor’s estate. Because the transaction is created as a sale on a note to be paid out over a significant length of time, the grantor can charge a low rate of interest which is not recognized as taxable interest income.


How can an IDGT benefit me?


IDGTs are most often used to benefit the grantor’s children or grandchildren. The trust’s assets are not considered part of the grantor’s estate. In this way, an IDGT differs from a revocable trust. That’s why the beneficiaries pay no taxes upon the grantor’s death.

The IDGT must be appropriately structured in order to be effective. If it is, the beauty of the IDGT allows the grantor to lower their taxable estate yet preserve assets for their beneficiaries at a specified value. This is one avenue to gift wealth to your children and grandchildren.


What happens to an IDGT when I die?


If you create an IDGT, have sold an asset or assets to the trust, and you still hold the promissory note, then those assets are still part of your taxable estate. However, if the promissory note is paid off and the IDGT now holds the assets free and clear, the IDGT’s assets will pass to its named beneficiaries.


Do you have questions about your estate documents? Feel free to call Sussan Greenwald & Wesler’s experienced attorneys for help at 609-409-3500

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