The Most Effective Estate Planning Technique The Intentionally Defective Grantor Trust
An Intentionally Defective Grantor Trust ("IDGT") may be the very best estate planning technique for transferring assets down
the generations with the least possible transfer tax consequences. The IDGT can be the best opportunity for those interested
in making sure more of their assets pass to their loved ones at death rather than to the government. In 2011, federal estate
tax rates are expected to increase to a top bracket of 55% and the exemption is dropping to $1 million. Therefore, it is
essential you plan your estate now.
What is an IDGT?
Generally a trust is a separate taxpayer that reports its own income and pays its own tax. However, a Grantor Trust is a trust
where the trust income is taxed to the grantor or creator of the trust rather than to the trust itself. There are basically two
types of Grantor Trusts. One is a Revocable Trust such as a Living Trust which is used as a planning device to avoid probate.
It does not save estate taxes. The other is an Irrevocable Trust used for estate tax planning purposes to save estate taxes
by removing assets from the gross estate. The beneficiaries of the trust are typically the spouse and the grantor’s descendants.
However, the trust is drafted in accordance with certain provisions of the Internal Revenue Code to have a "defect" that would
cause the income to be taxed to the grantor rather than to the trust (even though the grantor is not a beneficiary of the trust).
The attorney therefore drafts the trust to be intentionally defective so that the income earned by the trust is still taxed to
(but not received by) the grantor even though the assets in the IDGT are not included in the estate of the grantor.
Why would I want to be taxed on income I don’t receive?
Great question. The answer is buried in two Revenue Rulings published by the IRS. Rev. Rul. 85-13 and Rev. Rul. 2004-64 have made clear
that even though the grantor is paying the income tax on the income generated by the trust, the income tax payment is NOT an additional
gift for income tax purposes. Thus, the IDGT can grow without reduction for income taxes.
Example:
Dad uses his $1 million lifetime gift tax exemption and transfers cash or an asset to an IDGT. We suggest funding an IDGT with a closely held
business interest or a commercial real estate investment whose valuation on a discounted basis may have substantially declined because of the
economy, but in spite of the economy, still has good cash flow. An alternative might be a private equity investment or IPO that is expected
to appreciate in value.
Assume the rate of return is 10% so that the income generated is $100,000 per year. If the trust paid its own tax (and assuming no distributions out
of the trust) there would only be $1,055,000 in the trust at the end of the year assuming a 45% income tax bracket (the original principal of $1
million plus $100,000 of income less $45,000 in tax). However, if the trust income is taxed to the grantor and the grantor uses other non-trust
funds to pay the tax, there would be $1,100,000 in the trust at the end of the year instead of $1,055,000. The grantor is reducing his gross estate
without any transfer tax consequences by using other funds to pay the income tax on behalf of the IDGT.
Assuming the grantor uses other funds to pay the income tax and no distributions are made from the trust, after 20 years, there would be $6.7 million
in the IDGT versus $2.9 if it were a non- grantor trust. The difference of $3.8 million is in effect a tax free gift! If the principal or the rate of
return is higher, the results are even more dramatic.
Now is the time to review your assets and investment opportunities to determine what assets would be appropriate for an IDGT. Given current low valuations
of most assets, now would be a great time to implement or enhance your estate planning by creating an IDGT.
Maurice R. Kassimir, Esq.
Maurice Kassimir & Associates, P.C. mkassimir@mkpclaw.com
(212) 790-5719
Questions?
If you have any questions regarding this matter or any other estate planning techniques, please contact a Maurice Kassimir & Associates, P.C. Trusts & Estates attorney or e-mail us:
mkassimir@mkpclaw.com.
(212) 944-1377
Providing sophisticated estate planning to insure the accumulation, preservation and transfer of wealth for clients in the New York Metro area.
