Table of Contents
- What Is an Intentionally Defective Grantor Trust (IDGT)?
- Understanding Intentionally Defective Grantor Trusts (IDGTs)
- Estate Taxes
- Beneficiaries
- Important Note
- Selling Assets to an IDGT
- What Makes a Grantor Trust Intentionally Defective?
- How Are Intentionally Defective Grantor Trusts Taxed?
- What Happens to an Intentionally Defective Grantor Trust When the Grantor Dies?
- The Bottom Line
What Is an Intentionally Defective Grantor Trust (IDGT)?
Let me explain what an Intentionally Defective Grantor Trust, or IDGT, really is. It's an estate planning tool I use to manage how taxes hit certain assets. With an IDGT, you can pull assets out of your estate so they're not taxed there when you die, but you still handle the income taxes on what those assets earn.
This setup gives you a big advantage in cutting down estate taxes, all while you keep paying the income taxes on the earnings. It's straightforward once you get the basics.
Key Takeaways
- An intentionally defective grantor trust (IDGT) lets you separate certain trust assets to handle income taxes differently from estate taxes.
- It's basically a grantor trust with an intentional defect that keeps you paying the income taxes.
- IDGTs work best when beneficiaries are your children or grandchildren, and you've covered the income taxes on the assets they'll inherit.
Understanding Intentionally Defective Grantor Trusts (IDGTs)
Grantor trust rules from the IRS lay out when an irrevocable trust gets treated somewhat like a revocable one. That's where IDGTs come in—they're designed with a flaw on purpose.
In an IDGT, you stay on the hook for income taxes on the trust's earnings. But those assets aren't part of your estate at death. This means you transfer assets, reduce your estate tax load, and the assets' value is frozen for estate taxes while they keep growing in the trust.
Estate Taxes
For estate taxes, your estate's value drops by the amount you transfer to the trust. You 'sell' assets to the trust for a promissory note, say over 10 or 15 years.
The note pays enough interest to make the trust above-market, but expect the assets to grow faster than that.
Beneficiaries
Your children or grandchildren are usually the beneficiaries here. They get assets that have grown without you deducting income taxes from them—since you've paid those taxes already.
If you structure it right, an IDGT lowers your taxable estate and gifts assets to beneficiaries at a fixed value. Plus, by paying the trust's income taxes, you're essentially giving extra wealth to them.
Important Note
Because of how complex this is, you need to set up an IDGT with help from a qualified accountant, certified financial planner, or estate planning attorney. Don't try this alone.
Selling Assets to an IDGT
The IDGT structure lets you transfer assets by gift or sale. Gifting might hit you with gift taxes, so selling is often better. When you sell to an IDGT, there's no capital gain recognized, so no taxes due.
This is great for getting highly appreciated assets out of your estate. Usually, it's set up as a sale paid via an installment note over years. You can charge low interest, and it's not taxable income to you.
But you're still liable for any income the IDGT earns. If the asset produces income, like a rental or business, that income taxes back to you.
What Makes a Grantor Trust Intentionally Defective?
The 'intentionally defective' part means you no longer own the assets—they're out of your estate—but you still pay income taxes on what they earn in the trust.
How Are Intentionally Defective Grantor Trusts Taxed?
An IDGT doesn't get taxed on asset sales to the trust or on appreciation. You handle income taxes on the trust's earnings. The main point is assets are out for estate taxes, but their income stays taxable to you.
What Happens to an Intentionally Defective Grantor Trust When the Grantor Dies?
If there's an installment note, the principal and interest go into your taxable estate. But the sold assets stay out of the estate and pass to beneficiaries.
The Bottom Line
An IDGT freezes assets for estate tax purposes while you pay income taxes on their income. This reduces your estate tax hit and lets heirs get appreciated assets.
With all the details involved, make sure you talk to estate planning pros like accountants or attorneys to get it right.
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