Intentionally Defective Grantor Trust (IDGT)

The IDGT is a more advanced estate planning technique. Using an IDGT, the grantor can create a trust that is outside of their estate for estate tax purposes, but the grantor is still treated as the owner of the trust for income tax purposes. This is the ideal tax treatment for a client who is looking to minimize their estate tax burden, even though it may seem counter-intuitive to retain the income tax burden.

The fact that the grantor retains the income tax burden allows for a number of advantageous transactions. For example, assets gifted to the IDGT can serve as collateral leverage for sale transactions, sale transactions can be used to “freeze” the estate through the use of loans, and loans can be paid back in cash or in kind via property distributions without incurring additional income tax consequences (depending on state).

Transactions made with the IDGT must utilize a proper annual interest rate, however these rates are preferable to the 7520 rate associated with a GRAT. While there is the risk of effectively losing your federal estate tax credit should the funding asset decrease in value, the appreciation on the asset is not subject to the estate tax.

One of the most common IDGTs is known as a Spousal Lifetime Access Trust (SLAT). The SLAT is a technique that allows a married couple to maximize control over their assets while still receiving the tax benefits mentioned above. Properly drafted, the SLAT is an excellent inter-generational wealth transfer tool that maximizes the donor’s control over the trust assets while still retaining the tax benefits listed above. Unmarried individuals can also set up an IDGT with many of the same benefits of a SLAT, but there are additional challenges to funding the trust.

If you are interested in learning more about the IDGT, contact the Law Office of Kiran Mahal.