Using trusts as part of an estate plan creates many benefits, including minimizing estate taxes. One type of trust is known as an “intentionally defective grantor trust,” or IDGT. It’s a type of irrevocable trust used to limit tax liability when transferring wealth to heirs, as reported in the recent article “Intentionally Defective Grantor Trust (IDGT)” from Yahoo! Finance. It’s good to understand the details, so you can decide if an IDGT will help your family.
An irrevocable trust is one that can’t be changed once it’s created. Once assets are transferred into the trust, they can’t be transferred back out again, and the terms of the trust can’t be changed. You will want to talk with your estate planning attorney in detail about the use of the IDGT, before it is created.
An IDGT allows you to permanently remove assets from your estate. The assets are then managed by a trustee, who is a fiduciary and is responsible for managing the trust for the beneficiaries. All of this is written down in the trust documents.
However, what makes an IDGT trust different, is how assets are treated for tax purposes. The IDGT lets you transfer assets outside of your estate, which lets you avoid paying estate and gift taxes on the assets.
The IDGT gets its “defective” name from its structure, which is an intentional flaw designed to provide tax benefits for the trust grantor—the person who creates the trust—and their beneficiaries. The trust is defective because the grantor still pays income taxes on the income generated by the trust, even though the assets are no longer part of the estate. It seems like that would be a mistake, hence the term “defective.”
However, there’s a reason for that. The creation of an IDGT trust freezes the assets in the trust. Since it is irrevocable, the assets stay in the trust until the owner dies. During the owner’s lifetime, the assets can continue to appreciate in value and are free from any transfer taxes. The owner pays income taxes on the assets while they are living, and children or grandchildren don’t get stuck with paying the estate taxes after the owner dies. Typically, no estate tax applies on death with an IDGT. Whether there is a gift tax wen the gift is made to the IDGT will depend upon the value of the assets transferred to the trust and whether the owner has used up his or her lifetime generation-skipping tax exemption limit.
Your estate planning attorney can help establish an IDGT, which should be created to work with the rest of your estate plan. Be aware of any exceptions that might alter the trust’s status or result in assets being lumped in with your estate. Funding the IDGT also takes careful planning. The trust may be funded with an irrevocable gift of assets, or assets can be sold to the trust. Your attorney will be able to make recommendations, based on your specific situation.
One of the main goals of our law practice is to help families like your plan for safe, problem free, and successful transfer of assets to the next generation. Call our office today to schedule a time for us to review your estate plan and identify the best strategies for you and your family to ensure your legacy of love and financial security. Our office is located in Santa Ana, CA but we serve all of California including Irvine, Orange, Tustin, Newport Beach, and Anaheim.
Reference: Yahoo! Finance (June 3, 2020) “Intentionally Defective Grantor Trust (IDGT)”