The purpose of estate planning is to avoid taxation by eliminating as many of your taxable assets from your estate as possible. This can be done in a various ways. Transferring your assets to trusts is one very common way. However, there are many different kinds of trusts, each with its own benefits. An Intentionally Defective Grantor Trust, or IDGT, is one type of trust with which you should be familiar.
What is an Intentionally Defective Grantor Trust (IDGT)?
An Intentionally Defective Grantor Trust, or IDGT, is a type of trust drafted in such a way that it will invoke the “Grantor Trust Rules.” These rules say that a trust is considered a grantor trust only when the grantor has a reversionary interest of more than 5% of the trust assets. What does that mean? It means there is a provision that says the trust assets may be returned to the grantor or the grantor’s estate. This is important because, when a trust is considered a grantor trust, the income is taxed to the grantor instead of to the trust. Therefore, the tax rates for the trust will be much lower.
How do you create an IDGT?
There are essentially four ways to create an IDGT. The trustor, or the trustor’s spouse, can retain the power to recover the trust assets, or reacquire the trust property, in exchange for property of equal value. The trustor, or spouse, can also keep some benefit from the trust income. The trustor or spouse can expressly possess a revisionary interest worth more than 5% of the trust’s value, at the time it was created. Or, the trustor or spouse can retain control of when, and to whom, the trust income and principal will ultimately be distributed.
What are the Benefits of an IDGT?
All assets held in an Intentionally Defective Grantor Trust will grow without being diminished by income taxes. That is because the grantor pays the income taxes for the trust. As such, the value of the assets available to the beneficiaries of the trust will also increase. Another way to put it is, the tax payments made by the grantor are basically a gift to the trust beneficiaries – a gift that is free from transfer tax.
Another significant advantage is that the trust is taxed as a grantor trust, meaning there is no income tax assessed to the grantor when the assets are sold to the trust. As a result, transfers to an IDGT are said to be “effective” for estate tax purposes, but “defective” for income tax purposes.
How do you transfer assets to an IDGT?
Assets can be transferred to an IDGT in a many different ways. One common way to transfer assets is to gift the assets in their entirety. Another option is to gift only part of the assets and sell the rest to the trust.
If you have questions regarding IDGT trusts, or any other estate planning needs, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.