Intentionally Defective Grantor Trust (IDGT): What is It and What Are the Benefits?
Despite its no-so-appealing name, an intentionally defective grantor trust (IDGT) can prove to be a valuable estate planning tool for tax purposes. As an increasing number of Floridians incorporate IDGTs into their estate plans, this tool is not “defective” at all. On the contrary, it offers many benefits and can be effective for estate tax purposes.
Intentionally Defective Grantor Trust: What is It?
An IDGT is an irrevocable trust that is often created for the benefit of the grantor’s spouse or descendants. This trust planning instrument allows the grantor to transfer investment assets to family members during the life of the grantor.
The term “defective” in the trust’s name refers to a requirement that the grantor will pay the trust’s income tax during his or her life. With the IDGT, the grantor must maintain tax liability. In other words, the IDGT must contain a provision making it tax “effective” for estate tax purposes but, at the same time, tax “defective” for income tax purposes. The assets in the IDGT will not be considered part of the Grantor’s estate for estate tax purposes, therefore reducing a potential taxable estate at the Grantor’s death.
An IDGT is established as an irrevocable trust to remove the underlying trust assets from the grantor’s estate. With an IDGT, the trust income is taxed by the Grantor, not by the Trust.
Grantor Trust Provisions in an IDGT
Often, people who establish an intentionally defective grantor trust include the following grantor trust provisions:
- The power to substitute assets. The grantor can retain the ability to reacquire assets from the IDGT and replace them with assets of equivalent value.
- The ability to borrow from the trust. The grantor can retain the power to take loans from the IDGT without adequate interest or security. Also, other non-adverse parties may have the ability to borrow from the trust.
- The power of disposition. The grantor can retain the power to change or add noncharitable beneficiaries. The power of disposition also allows the grantor to add direct distributions to existing beneficiaries named in the trust.
It is critical to understand all the grantor trust provisions as well as the exceptions to them. Failure to understand how IDGT works may result in the loss of the grantor trust status. In addition, it may cause the trust to be included in the grantor’s estate for estate tax purposes.
What Are the Benefits of IDGTs?
The grantor and the beneficiaries can benefit from creating an intentionally defective grantor trust when funding it with appreciating assets. This instrument serves two purposes:
- Gives the beneficiaries the advantage of the appreciation without having to pay additional transfer taxes; and
- Removes assets from the grantor’s estate by transferring them into an irrevocable trust.
In addition, the income taxes paid by the owner of the IDGT further decrease the value of the estate. These taxes do not count as additional gifts to the trust or the beneficiaries.
Another benefit of an IDGT is that it is a grantor trust and gives the grantor the ability to control the beneficial enjoyment of the trust, unlike other irrevocable trusts that require the grantor to relinquish all rights and powers regarding the trust and its assets. Thus, even though an IDGT is irrevocable by design, it still offers both tax benefits and the ability to retain control.
Consult with a St. Petersburg estate planning attorney to determine whether you can benefit from creating an intentionally defective grantor trust (IDGT) in Florida. Contact Legacy Protection Lawyers, LLP, for a consultation at 727-471-5868, or complete our contact form on our website.