Intentionally defective grantor trusts survive the threat of extinction

March 06, 2013

Intentionally defective grantor trusts survive the threat of extinction

Article provided by Louis Pacella Law Offices
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Intentionally defective grantor trusts have long been a staple of estate planning. They help reduce the size of a person's estate for estate tax purposes, and they also keep the amount of taxes that the beneficiaries of the trust must pay low. President Obama's 2012 budget proposal recommended changes to the law that would have eliminated the financial benefits of these trusts, causing concern around the time of the so-called fiscal cliff, but the proposal was not accepted by Congress. Accordingly, IDGTs can continue to provide benefits to those who engage in thoughtful estate planning.

How IDGTs operate

IDGTs take advantage of a split between the tax rules for money transfers or gifts and the rules for income. When a grantor establishes an IDGT, he or she transfers assets out of his or her estate so the total taxable estate is smaller. However, the grantor does not sever the link between himself or herself and the income tax responsibilities for those assets. The grantor keeps paying the taxes on the assets as if he or she still owns them, meaning that the trust assets do not have to pay the taxes, and, therefore, more assets are available for the beneficiaries.

Typically, people sell assets to an IDGT because tax laws treat it as a sale to oneself, which is a non-taxable event for income tax purposes. Since the trust pays market value for the assets, the transfer is not considered a gift for gift tax purposes, either. In addition, grantors often charge the trust interest on installment payments for the assets at the applicable federal rate to ensure the sale is not seen as a gift by the I.R.S.

Proposed changes to IDGT laws

Pres. Obama's federal budget proposal sought to change the rules so the assets a grantor transfers into an IDGT would still be included in the grantor's estate when calculating the estate tax. The proposal also would have made any distribution of trust assets during the grantor's life subject to gift tax. Finally, all the assets of the trust would have been subject to gift tax if the grantor ceased ownership of the trust (by no longer paying its income taxes) at any point during his or her life. Fortunately for those who use IDGTs, though, these proposals were not accepted by Congress in the 11th-hour American Taxpayer Relief Act.

Consult an attorney

Establishing trusts can be complicated, particularly when the laws regulating them are in flux. If you have questions concerning setting up a trust or the status of a current trust, speak with a qualified estate planning attorney to discuss your situation.