What Are Intentionally Defective Grantor Trusts?
An Intentionally Defective Grantor Trust (IDGT) is a unique type of irrevocable trust designed with specific tax advantages in mind, as established under Internal Revenue Code Section 671. While the term “defective” might sound concerning, it’s actually a strategic feature.
In an IDGT, the grantor (the person creating the trust) retains certain powers over the trust, making them liable for its income taxes. This might seem counterintuitive, but it can lead to significant estate and gift tax savings. If you’re seeking to optimize your estate plan, the Law Offices of Terri D. Mason, P.C. can discuss how an IDGT could be a valuable tool for you.
How Does an IDGT Work?
An IDGT is a type of irrevocable trust that allows the grantor to retain certain powers over the trust assets. This means the grantor can still make decisions about how the trust assets are invested and used. However, because the grantor retains these powers, the trust assets are considered part of the grantor’s taxable estate for estate tax purposes.
Despite this, IDGTs can still be a valuable estate planning tool. This is because the grantor can make gifts to the trust without incurring gift taxes. The gifts are considered incomplete for gift tax purposes because the grantor retains some control over the trust assets.
In addition, the income generated by the trust assets is taxed at the grantor’s individual income tax rate, which is often lower than the trust’s tax rate. This can cause significant tax savings.
Finally, IDGTs can be used to protect assets from creditors. This is because the assets in the trust are generally not considered part of the grantor’s estate for creditors’ purposes. Here is an example of how an IDGT can work:
A grantor creates an IDGT and transfers $1 million worth of assets to the trust. The grantor retains the power to make investment decisions for the trust assets. The grantor also retains the power to revoke the trust at any time.
The trust generates $50,000 of income each year. This income is taxed at the grantor’s individual income tax rate, which is 37%. As a result, the grantor pays $18,500 in income taxes on the trust income each year.
The grantor dies five years later. At that time, the trust assets are worth $1.5 million. Because the grantor retained the power to revoke the trust, the trust assets are not included in the grantor’s taxable estate for estate tax purposes. As a result, the grantor’s estate does not owe any estate taxes on the trust assets.
In this example, the IDGT saved the grantor’s estate $525,000 in estate taxes. This is because the grantor was able to make gifts to the trust without incurring gift taxes, and the trust assets were not included in the grantor’s taxable estate for estate tax purposes.
Overall, IDGTs can be a complex but valuable estate planning tool. If you are considering using an IDGT, it is important to consult with an experienced estate planning attorney to discuss whether it is right for you.
Who Should Consider an Intentionally Defective Grantor Trust?
An IDGT might be a suitable estate planning tool for individuals who:
- Have a high net worth and want to minimize estate and gift taxes.
- Own assets that are expected to appreciate significantly.
- Are willing to pay income taxes on trust income in exchange for estate tax benefits.
- Want to provide financial support to their beneficiaries while maintaining some control over the trust assets.
Is an Intentionally Defective Grantor Trust Right for You?
If you are considering an Intentionally Defective Grantor Trust as part of your estate plan, it’s crucial to seek guidance from an experienced estate planning attorney. The Law Offices of Terri D. Mason, P.C., with 29 years of experience, can help you understand the intricacies of IDGTs and determine if they align with your financial goals and family needs. Contact us today to schedule a consultation and explore how an IDGT can benefit your estate plan.