What happens when the grantor trust that’s been set up was intended to be defective? Sometimes, they’re supposed to be that way. IDGTs are a type of grantor trust that is purposefully broken by design so that the New York grantor can ensure that the income tax payments keep coming.
What are intentionally defective grantor trusts used for?
An intentionally defective grantor trust is valuable a tool used in estate planning. Grantors use it to freeze specific assets of an individual’s estate to make sure that they keep paying their income taxes.
It’s important to note that you can only use an IDGT to freeze assets this tool is for estate tax purposes as opposed to income tax purposes. Upon the death of the grantor, no estate taxes are incurred by the estate. However, the grantor still has to pay the income tax on any income that’s generated.
The upshot of using an IDGT is that you’re able to segregate the targeted trust assets so you can keep the income tax separated from the estate tax treatment. Because of the loophole built into intentionally defective grantor trusts, a grantor can receive funds from specific trust assets.
When are intentionally defective grantor trusts useful?
For an IDGT to be effective, it has to be structured in a way that’s appropriate for your estate planning situation. An IDGT will oftentimes come into play if a trust beneficiary is the grantor’s child or grandchild.
With an intentionally defective grantor trust, you can lock in the value of certain assets by gifting them to beneficiaries, lowering their taxable estate. You’ll often see IDGTs used when estate planning is a family matter and the grantor has made income tax payments to help grow the assets that will eventually be inherited.