Intentionally Defective Grantor Trust (IDGT)
What Is an Intentionally Defective Grantor Trust?
An intentionally defective grantor (IDGT) trust is an estate-planning instrument that is utilized to freeze certain assets of an individual for estate tax purposes, however not for income tax purposes. The intentionally defective trust is made as a grantor trust with a loophole that allows the trustor to continue paying income taxes on certain trust assets, as income tax laws won't perceive that those assets have been transferred away from the individual.
Since the grantor must pay the taxes on all trust income yearly, the assets in the trust are allowed to develop tax-free, and subsequently stay away from gift taxation for the grantor's beneficiaries. In this manner, it is a loophole used to reduce estate tax exposure.
Understanding Intentionally Defective Grantor Trusts
Grantor trust rules outline certain conditions when a irrevocable trust can receive a portion of similar treatments as a revocable trust by the Internal Revenue Service (IRS). These circumstances some of the time lead to the creation of what are known as intentionally defective grantor trusts. In these cases, a grantor is liable for paying taxes on the income the trust generates, however trust assets are not combined with the proprietor's estate. Such assets would apply to a grantor's estate if the individual runs a revocable trust, nonetheless, on the grounds that the individual would effectively still own property held by the trust.
For estate tax purposes, however, the value of the grantor's estate is reduced by the amount of the asset transfer. The individual will "sell" assets to the trust in exchange for a promissory note of some length, like 10 or 15 years. The note will pay sufficient interest to group the trust as above-market, yet the underlying assets are expected to appreciate at a quicker rate.
The beneficiaries of IDGTs are commonly children or grandchildren who will receive assets that have had the option to develop without reductions for income taxes, which the grantor has paid. The IDGT can be an extremely effective estate-planning device whenever structured appropriately, allowing a person to lower their taxable estate while gifting assets to beneficiaries at a locked-in value. The trust's grantor can likewise lower their taxable estate by paying income taxes on the trust assets, basically gifting extra wealth to beneficiaries.
Selling Assets to an Intentionally Defective Grantor Trust
The structure of an IDGT allows the grantor to transfer assets to the trust either by gift or sale. Gifting a asset to an IDGT could trigger a gift tax, so the better alternative is sell the asset to the trust. At the point when assets are sold to an IDGT, there is no recognition of a capital gain, and that means no taxes are owed.
Due to the complexity, an IDGT ought to be structured with the assistance of a qualified accountant, certified financial planner (CFP), or a estate-planning attorney.
This is great for removing profoundly valued assets from the estate. In many cases, the transaction is structured as a sale to the trust, to be paid for in the form of an installment note, payable north of several years. The grantor receiving the loan payments can charge a low rate of interest, which isn't recognized as taxable interest income. Be that as it may, the grantor is liable for any income the IDGT acquires. On the off chance that the asset sold to the trust is an income-producing one, for example, a rental property or a business, the income generated inside the trust is taxable to the grantor.
Features
- It is effectively a grantor trust with a deliberate flaw that guarantees the individual continues to pay income taxes.
- An intentionally defective grantor (IDGT) allows a trustor to detach certain trust assets in order to isolate income tax from estate tax treatment on them.
- IDGTs are most frequently used when the trust beneficiaries are children or grandchildren where the grantor has paid income tax on the growth of assets that they will inherit.
