When I first started doing estate planning, I was amazed at how many people thought that it was something only for the wealthy.  That is simply not true.  Everyone, no matter the size of your estate, can benefit from having an estate plan.  Even if an estate planning tool has been primarily used by the wealthy, it does not mean that more modest estates could not also benefit from using the same tool. 

Many of the country’s wealthiest families have an Estate Plan in place to help facilitate a smoother transfer of assets from the decedent to the heirs AND save significantly on taxes. What’s more? Their method of choice is one that anyone can use – particularly for select types of assets you may have. I am talking about an Intentionally Defective Grantor Trust.

What Is An Intentionally Defective Grantor Trust (IDGT)?

An intentionally defective grantor trust (IDGT) is a common Estate Planning tool that is used by wealthy families to transfer assets from one generation to the next while achieving significant tax savings. IDGTs are especially useful if you have assets that will appreciate significantly over time.  

An IDGT is “intentionally defective” because it purposely gives the grantor – the person creating the trust – a right or power that allows the grantor to pay taxes on the income generated by the trust even though the trust assets are not a part of the grantor’s estate. The trust is irrevocable, which means the trust assets will not be counted for estate tax purposes. Transferring assets to an IDGT takes the assets out of an estate while the trust’s income is taxed at the grantor’s personal rate, not the trust’s much higher rate. 

Benefits Of An IDGT

The benefit of an IDGT is that it allows the trust to grow without having to use trust assets to pay income taxes. This amounts to a tax-free gift to the trust. In addition, by paying the income taxes, you are also continuing to lower your taxable estate. IDGTs work best for assets that are likely to appreciate significantly in value, such as stock or real estate.

For example, suppose you fund an 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 from its own assets, its growth would likely be significantly less. 

Bear in mind that when you transfer the assets to the trust, the transfer may be subject to gift taxes. Currently, the annual gift tax exclusion is $16,000 (for 2022). This means that any person who gives away $16,000 or less to any one individual (anyone other than their spouse) does not have to report the gift or gifts to the IRS. In addition, the IRS allows you to give away a total of $12.06 million (in 2022) during your lifetime before a gift tax is owed. Even if you gift assets to an IDGT and reduce your future gift and estate tax exemption, any future growth will occur outside of your estate. 

If you want to avoid gift taxes, you may be able to sell assets to the trust. This is usually done in installments through an interest-bearing promissory note. When an asset is sold to an IDGT, there are no capital gains taxes because you are selling something to yourself. If the assets in the trust gain more in value than the interest rate, then the sale will still benefit the trust overall. This strategy works best when interest rates are low.  

Is An IDGT Right For You?

Whether you’re just looking to begin your Estate Planning or update your current Estate Plan, it’s highly advisable to consult with an Estate Planning attorney to find out if an IDGT is right for you.

There are many ways to configure an Estate Plan and it’s important to find a lawyer who can help you in creating and executing the ideal plan for you and your family.

At the Law Office of Antoinette Bone, we understand that no two family or personal situations are the same – that’s why we take a personalized approach with all of our clients. We look forward to helping you customize an Estate Plan that fulfills your unique needs and considerations. Click the link to book an appointment or call us at (817) 462-5454 to schedule a meeting with Antoinette Bone in our Euless, Texas office.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

Nothing in this message is intended to provide legal advice.  This message is for educational purposes only.