Effective estate planning involves utilizing all the necessary tools to not only protect the assets you have but also avoid unnecessary taxes whenever possible. Intentionally Defective Grantor Trusts (IDGT) can accomplish this for individuals who hold high-value assets that have grown in value since the original date of purchase.
This type of trust allows one’s assets to continue generating income while avoiding estate or other types taxes on those assets. Taking advantage of the potentially significant savings requires careful planning and consideration, however.
Establishing an Intentionally Defective Grantor Trust
In the case of an IDGT, a grantor will establish the trust that positions themselves as the owner of the trust for income tax purposes. This irrevocable trust remains separate from the grantor’s estate, allowing assets held within the IDGT to continue to appreciate without triggering estate tax liability for the grantor.
The owner could potentially avoid capital gains taxes as well. Assets would be sold to the trust in exchange for a promissory note with an interest rate reflective of the applicable federal interest rate at that time. The only tax that the grantor will be responsible for is the tax on any income generated by trust assets. This includes income from rental properties or businesses governed by the trust.
When an IDGT is Beneficial
Intentionally Defective Grantor Trusts are not necessarily beneficial for everyone. In general, these are more advantageous for individuals who have assets that have appreciated significantly over time.
Because the grantor is responsible for satisfying income taxes incurred by assets held within the trust, there needs to be a financial incentive to establish the trust. This incentive can be realized as long as the capital gains and/or estate taxes that no longer have to be paid exceed the amount of income taxes owed by the trust.
For instance, if Grant purchased an asset worth $350,000 but sold it several years later for $850,000, he would owe capital gains taxes on the difference of $500,000. Assuming Grant has already sold other capital assets at a gain and must pay taxes at the highest rate, he pays a 20% federal capital gains tax, along with a 13.3% state capital gains tax. He could potentially avoid this by selling the asset to the IDGT he established.
Properly Establishing an IDGT is Crucial
All of this is fantastic news for you if you have high-value assets that have appreciated in value, but it’s of no use if not executed properly. In fact, you may incur additional taxes if it is not done properly, eliminating any benefit and actually resulting in you incurring more in taxes. An experienced attorney who understands estate and tax law can help you put an Intentionally Defective Grantor Trust into motion and ensure it works as intended.
At The Law Offices of Tyler Q. Dahl, we can help you navigate these complex planning tools to get the most out of your estate. Contact our team today.
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