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How does an intentionally defective grantor trust work?

On Behalf of | Nov 8, 2022 | ELDER LAW - Estate Planning

Estate planning for Connecticut residents can be a complicated and even counterintuitive process. This is especially true when significant assets are at stake.

One of the tools at your disposal in planning your estate is an intentionally defective grantor trust (IDGT). An IDGT is a subtype of a grantor trust, but with a purposeful flaw that allows the grantor to pay income taxes on their assets.

What is an IDGT?

An intentionally defective grantor trust allows for a person (the grantor) to designate certain of their assets such that the grantor will pay income taxes on those assets. However, when the grantor passes away and the assets transfer to any beneficiaries, these assets aren’t subject to the estate tax.

In effect, an IDGT allows an estate planner to make a tradeoff, paying income taxes up front while freeing those assets from incurring any estate taxes in the future.

Why use an IDGT?

The main reason to use an IDGT is so that children or grandchildren can receive assets which have been given the change to grow, not having to worry about income taxes. In an IDGT, the income taxes have already been paid.

When the assets transfer to the beneficiaries, they will not be subject to estate taxes. So for individuals with substantial assets, an IDGT can lower the estate tax burden at the time of the grantor’s death.

An IDGT allows a sort of middle ground, locking in the value of assets when the time comes for beneficiaries to inherit them.

An IDGT isn’t right for every estate, as many times other trusts will provide better taxation value when weighing both the short and long term. But an IDGT is a useful tool in any estate planner’s belt, as certain types of assets benefit greatly from an IDGT.