An Intentionally Defective Grantor Trust (IDGT), also known as a Defective Grantor Trust (DGT), is an advanced estate planning tool that has become increasingly popular for individuals seeking to transfer assets to heirs while minimizing estate and gift taxes. This trust is “defective” in the sense that it is structured in a way that it is considered irrevocable for estate and gift tax purposes but “defective” for income tax purposes, which can provide certain benefits to the grantor.

How an Intentionally Defective Grantor Trust Works

• Irrevocable for Estate and Gift Tax Purposes: From an estate and gift tax perspective, an IDGT is treated as an irrevocable trust, meaning that once assets are transferred into the trust, they are no longer considered part of the grantor’s taxable estate. This can help reduce the grantor’s future estate tax liability.
• Defective for Income Tax Purposes: Despite being irrevocable for estate and gift tax purposes, a IDGT is structured to be “defective” for income tax purposes. This means that the grantor, who initially funds the trust, is still treated as the owner of the trust for income tax purposes. Consequently, the grantor is responsible for paying income taxes on trust income generated by the trust assets.
• Substitution Powers: One of the key features of an IDGT is that it typically includes a power for the grantor to substitute assets of equivalent value into the trust. This power allows the grantor to exchange low-basis assets within the trust with high-basis assets from their own estate. This strategy can help minimize capital gains tax liability for the grantor’s heirs when they eventually sell the trust assets.

Benefits of an Intentionally Defective Grantor Trust Strategy

• Reduced Estate Tax Exposure: The primary benefit of an IDGT is the reduction of the grantor’s taxable estate. By transferring assets into the trust, the grantor removes them from their estate, which can significantly lower the potential estate tax liability upon their passing.
• Minimized Capital Gains Tax: Through the use of asset substitutions, an IDGT can help heirs receive assets with a stepped-up basis, which can reduce capital gains taxes when they sell those assets in the future.
• Gift Tax Efficiency: IDGTs allow grantors to make tax-efficient gifts to beneficiaries without incurring gift tax liability because the trust is incomplete for income tax purposes. This can be especially advantageous when transferring assets that are expected to appreciate significantly over time.

Intentionally Defective Grantor Trusts are complex estate planning tools that require careful consideration and proper legal structuring. They are typically used by individuals with substantial estates who want to pass wealth to heirs while managing estate and gift tax implications. Working with an experienced estate planning attorney or financial advisor is essential when considering the use of an IDGT to ensure it aligns with the grantor’s specific financial and estate planning goals.

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Note: The information provided here is for general educational and informational purposes only. It is not legal advice and should not be interpreted as such. For a thorough understanding of these topics relevant to your specific circumstances, we recommend consulting a qualified estate planning attorney. Peak Trust Company cannot provide legal advice; however, we can serve as an informational resource and provide referrals to highly skilled attorneys who can offer legal and tax guidance tailored to your specific needs.