An Intentionally Defective Grantor Trust (also known as an "IDGT") is a powerful estate planning tool that can be used to supplement your current estate plan.
An IDGT is an irrevocable trust. This means that the person who creates the trust, also known as the grantor, generally cannot revoke or amend the trust after creation.
An IDGT is a hybrid vehicle for tax purposes. Any assets that are transferred to an IDGT are completed gifts for estate and gift tax purposes and thus are removed from the grantor's estate and not subject to estate tax on death. However, for income tax purposes, the trust is treated as still being owned by the grantor if such person retains certain "grantor trust" powers set forth in the Internal Revenue Code. One of the common "grantor trust" powers that is given to the grantor is the power to substitute assets owned by the trust for assets of an equivalent value. The grantor pays all of the taxes on the income earned by the trust. This allows more assets to be transferred to the grantor's heirs without increasing estate tax exposure.
An IDGT can be funded with appreciated stock or LLC interests. This allows the grantor to freeze the value of these assets for estate and gift tax purposes. This is especially useful if the value of the stock or LLC interests is expected to grow in value over time.
An IDGT can also be used to purchase assets from the grantor directly without incurring income tax consequences. Since the grantor is the owner of the assets before the transaction and treated as the owner after the transaction, it is treated as if nothing has occurred for income tax purposes. Debt can also be used to further enhance estate tax savings.
While an IDGT is not for everyone, if you think that your estate may end up being close to the federal or a state estate exemption, funding an IDGT could be a beneficial tool to lower estate taxes.