If you are putting together an estate plan and are searching for the best way to achieve the goals of minimizing the tax costs of transferring wealth, then perhaps you should consider utilizing an intentionally defective grantor trust (IDGT). If you are unfamiliar with an IDGT, this article should help you get to know this estate planning device a little better.
Why is it “defective”?
The only reason it is called a defective trust is because the trust is not a separate entity from the grantor; at least, not as far as the Internal Revenue Service is concerned. Therefore, the grantor cannot use the trust to avoid paying income taxes.
How does it work?
As indicated in the previous question, when it comes to income taxes the IDGT works by treating the grantor as the owner of the trust. The unique aspect of the IDGT is that it also works to allow the value of the assets placed into the trust (it is this value that is used in assessing income taxes) to be omitted when calculating the value of your estate. When it comes to the gift tax, transferring an asset into this trust, which is an irrevocable trust, is considered to be complete.
What should a grantor report on his or her income taxes?
If you’re a grantor, you should report all income, gain, loss, deduction and credit that result from the IDGT on your federal income tax return. Your state reporting requirements may vary, so don’t assume it will be the same.