An intentionally defective grantor trust (IDGT) is an estate planning device used by wealthy families to transfer their estate assets to their heirs while achieving substantial tax savings.
An IDGT is ‘intentionally defective” because it purposely gives the grantor a power to pay taxes on the income generated by the trust even though the trust assets are not part of the grantor’s estate. The trust is irrevocable which means the trust assets will not be counted for estate tax purposes.
Thus, transferring assets to an IGDT takes the ASSETS out of an estate while the trust’s INCOME is taxed at the grantor’s personal tax rate, not the trust’s much higher rate.
The benefit of an IGDT is that it allows the trust to grow without having to use trust assets to pay income taxes, which is essentially a tax-free gift to the trust. In addition, by paying the income taxes, you are also continuing to reduce your taxable estate.
An IDGT works best for assets that are likely to appreciate significantly in value such as real estate or stock. For example, suppose you fund and IDGT with $10 million in assets and it earns 5 percent annually over a 30-year period. If the trust does not have to pay income tax, it might grow to more than $43 million. If the trust needs to pay income taxes on its own assets, its growth would be significantly less.
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