How an Intentionally Defective Grantor Trust (IDGT) Can Benefit Large Estates

Did you know gifting estate assets to family members is a common strategy for avoiding estate taxes levied after you pass away? It is not, however, as easy as handing over property and investments and calling it a day. Knowing the rules of estate planning and utilizing specific wealth-building strategies can not only help you mitigate estate-draining taxes but also ensure asset growth and the security of your heirs.

Currently, the IRS allows you to give away up to $15,000 a year without penalty. Anything over the annual “gift tax exclusion” will reduce your taxable estate exemption. At an exemption of $11.58 million in 2020, most people will not have to worry about federal estate taxes, but keep in mind that the estate exemption is scheduled to be cut approximately in half in 2026, and federal election changes could easily lead to a lower limit at a more rapid pace. This is something to take seriously and speak with your estate planning attorney about sooner, rather than later.

Additionally, the federal estate tax, or “death tax” depending on your perspective, can reach 40 percent. Fifteen states and the District of Columbia also levy an estate tax, and another six states have an inheritance tax. While large estate-holders should definitely consider lowering the value of their estates, so should moderately-sized estates with assets likely to appreciate in the coming years.

One innovative wealth transfer vehicle is the Intentionally Defective Grantor Trust, or an IDGT. Let us give you more insight into how it works. When you put income-producing assets in an IDGT, you, the grantor, pay the income taxes. Normally, a trust would pay the income taxes on the trust’s assets, thus reducing the value of the assets held in the trust as well as the proceeds the beneficiaries would receive. When the grantor pays the trust’s income taxes, however, the assets are able to grow income tax-free, and the grantor’s estate is reduced by the amount of the income tax payments he or she makes. An added benefit is that the IRS does not consider this form of wealth transfer a taxable gift, so your beneficiaries can keep more of their inheritance especially as the IDGT assets appreciate in value.  And finally, individuals generally pay income tax at lower tax rates than do trusts, so there is an income tax-savings benefit.

We know this topic may raise many more questions than it answers and cause you to think carefully about your own Florida estate planning strategies. Tax mitigation strategies and IDGTs can be complicated and depend on an estate’s individual circumstances. We encourage you to contact us for guidance on this, or any other estate planning issue, today.