Intentionally Defective Grantor Trusts

The Tax Reduction and Jobs Creation Act of 2017 (The 2017 Act) reduced the  number of taxpayers who might be subject to Estate Tax upon their death. The Estate Tax exempts estates under a specific exemption amount. For 2024, the exemption amount is $13.6 million or for married couples up to $27.22 million. The size of this exception has made the need to focus on estate tax planning less critical. However, the 2017 Act is due to sunset after December 31, 2025 and the exemption is scheduled to be reduced to $5 million per person indexed for inflation. Therefore, absent a change in the tax legislation, a great many families that for the last several years did not have to be concerned with Estate Tax may have to consider Estate Planning to retain the family wealth.

Over the next several months we will be describing a number of tax planning techniques which could save families substantial amounts of future estate tax.  The first of these techniques is the use of an Intentionally Defective Grantor Trust (IDGT)

An IDGT is an estate planning tool used to freeze the value of certain assets for estate tax purposes but not for income tax purposes. The income generated by the transferred asset(s) is taxed at the grantor level while the value is removed from his estate.

An example of how this works is as follows;

Dad owes 100% of the stock in an S Corporation. The value of the company is $10 million. In this strategy he transfers 100% of the stock to a IDGT in exchange for a Note of $10 million with interest payable at the applicable federal rate. For income tax purposes Dad still reports income on the transferred stock since it is a grantor trust and nothing has changed from an income tax perspective. The gain on sale of the stock and the corresponding interest is not taxable since the trust is for tax purposes is the same as the Grantor.

Therefore if Dad passes away ten years after the transfer when the company is worth $20 million  then the value of the stock will not be taxable in his estate . His estate would have a taxable asset equal to the $10 million note less the amount of any principal paid down on the note.

The use of an IDGT can be a very effective Estate Tax Planning tool, and with the possibility of a dramatic change in estate taxation in a little more than a year and half, could be something successful owners of a family owned business should consider

We at Stephano Slack have assisted many clients in their estate planning including the use of IDGT. If this something you would like to explore in more detail, please contact your tax partner and or manager to discuss.