An intentionally defective grantor trust, or IDGT, is a way of shifting tax burdens for very wealthy households. With this structure, you can create a trust that leaves wealth to your heirs while minimizing gift, estate and income tax liability. Find out how the IDGT works and what tax advantages may exist if you decide to create one. A financial advisor can walk you through all of the ins and outs of each type of trust and help you determine the right financial strategy to use the IDGT or another type that may be more beneficial.
What Is an Intentionally Defective Grantor Trust?
An intentionally defective grantor trust (“IDGT”) is a form of trust that’s used for managing estate and gift taxes. It’s most useful for assets that generate significant revenues over time, for example, high-yield investments and real estate.
It is potentially least helpful for low-yield, high-appreciation assets. Estate law lets you step up the tax basis of assets that you leave to your heirs through inheritance law, helping them to reduce capital gains taxes. An intentionally defective grantor trust generally does not allow you to do this, minimizing estate taxes while potentially maximizing capital gains liability.
To establish an IDGT, you create an irrevocable trust, meaning that you cannot rescind or change the trust once it’s been created. Legally, the trust becomes a third party. Any assets you put into this trust no longer count as part of your household or estate for tax purposes, but you also cannot access those assets for your own use.
You then make that trust legally defective by including language in the trust agreement that reserves the right for you to access or use its assets in some way. Most people do this by retaining the right to swap assets in the trust for assets of equal value that they own, but any rights to access or use the trust’s assets will generally do.
The result is a trust with mixed legal status. You effectively surrender control over its assets, so the trust’s beneficiaries can receive their distributions tax-free. However, you technically retain some control over your assets, so the IRS considers you the owner for income tax purposes.