Intentionally Defective Grantor Trusts ("IDGTs")
An Intentionally Defective Grantor Trust (“IDGT”) is a type of irrevocable trust that is designed to be outside of your estate for estate tax purposes, but not for income tax purposes. An IDGT passes all items of income, credit and deductions through to your personal income tax return. This is beneficial for a few reasons.
First, you would be responsible individually for the income tax on the income earned by the IDGT. Ideally, this would be paid from your own assets, so that the IDGT is not depleted. By paying the income tax liability on behalf of the IDGT, you allow the IDGT to grow “income-tax free” while reducing the portion of your estate subject to estate taxes and creditors. This is often called the “tax burn.”
Second, any transactions between yourself and the IDGT are ignored for income tax purposes. This means that you can loan money to the IDGT for a new investment, or sell assets to the IDGT without triggering a capital gain. When you sell an asset to the IDGT, it is typically structured as an installment note sale, paying interest to you for a term of years, with a balloon payment of principal. The installment note sale allows you to leverage your gift tax exemption to further reduce the part of your estate exposed to estate taxes.
For more information on IDGTs and/or an installment note sale to an IDGT, please contact us.