The IDGT Strategy’s Components
A sale to an intentionally defective grantor trust (IDGT) is a strategy with two primary components. The first component is the IDGT. An IDGT is termed “defective” because, although a transfer of property to the trust is considered complete for gift and estate tax purposes, the grantor is still deemed the owner of the property for income tax purposes. Consequently, he or she is responsible for any income tax liability associated with trust assets.
Payment of income tax liability by the grantor allows the trust to grow without the drag of taxes against the trust corpus. In addition, by paying those taxes, the grantor further reduces his or her taxable estate. In short, he or she creates a trust for the benefit of heirs that will grow essentially without tax liability and that is essentially a tax-free gift.
Another significant benefit of the IDGT’s grantor trust status is evident in the second component of this strategy, the installment sale. A sale by the grantor to a grantor trust is not a recognition event for income tax purposes because the trust is deemed to be the “alter ego” of the grantor; therefore, it is as if the grantor were making a sale to him- or herself. The nonrecognition of income upon the sale is a primary factor in the ultimate success of a sale to an IDGT.
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