Why Would You Want an Intentionally Defective Grantor Trust (IDGT)?
An Intentionally Defective Grantor Trust (IDGT) can limit estate tax exposure and, in some cases, be used for creditor protection (Medicaid Trust). This trust’s “Defective” portion allows the creator to pay income tax on the assets held within the trust without receiving the income. You can protect assets in an IDGT and make future income tax payments on those assets without the payments being included as another gift. You can also sell your personal assets to this trust and not trigger a taxable gain (if your social security number is on both “sides” of a transaction, there is no taxable gain). The ability to do this is key for other complex estate planning concepts.
When preparing a trust income tax return, confirming whether it is a grantor or non-grantor trust is important. It might also be necessary to file a gift tax return when an IDGT is funded, depending on whether the transfer to the trust is a complete or incomplete gift.
For the IDGT, while the trust’s creator must pay the income tax, the trust can reimburse the tax payment. In this type of provision, you must be cautious because if reimbursement is required, the entire trust is included in the creator’s estate (and subject to estate tax). If, however, the trust allows the trustee (or a committee/trust protector) discretion to reimburse, the existence of this discretion, whether exercised or not, does not pull the trust into the creator’s estate. (Revenue Ruling 2004-64)
Is it Irrevocable or Revocable?
An Intentionally Defective Grantor Trust is irrevocable, meaning it cannot be changed once created. But there are circumstances where modifications are possible even though the trust is irrevocable. This could be using a Trust Protector (also known as a Trust Advisor), decanting, reformation (judicial or nonjudicial), Private Settlement Agreement, or as otherwise permitted by state law.
Is a Separate Tax Identification Required?
The IDGT does not require a separate Tax Identification Number; the creator (Settlor or Grantor) would use their social security number as the identification number. Upon death, a social security number can no longer be used.
Can You Be Your Own Trustee?
While it is possible to be your own Trustee of an Intentionally Defective Grantor Trust, it is rarely beneficial. In most cases, you would appoint a third party to serve as the Trustee of the IDGT.
Is a Gift Tax Return Required?
It depends on the structure of the Intentionally Defective Grantor Trust. Sometimes, you will have a trust that constitutes a completed gift (thus, a gift tax return is required). In other cases, the IDGT will own assets as an “incomplete gift, ” meaning a gift tax return is not required.
Is This Subject to Estate Tax Upon My Death?
It depends. If the Intentionally Defective Grantor Trust were created to avoid estate tax inclusion, it would not be in your taxable estate. For an IDGT created for reasons other than minimizing estate tax, they would likely be included in your taxable estate (based on the asset level at death; hopefully, no estate tax would be owed).
Is There Creditor Protection?
Yes, there can be creditor protection with an IDGT. The level of protection will depend on the terms of the trust. Generally, the more access a beneficiary has to assets, the less protection they would receive from creditors.
What Assets Can Be Placed in This Type of Trust?
An IDGT can own almost any type of asset. The one asset it cannot own is a retirement account. You would not want to place any retirement accounts into an IDGT because doing so would trigger taxes and potential penalties.
Usually, an IDGT is designed to be ignored for income tax purposes but is still effective for estate tax purposes. Retirement accounts such as IRAs and 401(k)s are already tax-deferred, and placing them into an IDGT would trigger taxes and potential penalties, which defeats the purpose of having a retirement account in the first place.
It is also important to note that a trust used for estate tax planning should include provisions that prohibit the funds from coming back to the creator of the Trust to avoid estate tax inclusion.
Contact a Trust Attorney today to schedule a consultation and learn more about how we can help you with your estate planning needs.