Long Island Elder Law & Estate Planning

Long Island asset protection planning attorney

For anyone with considerable assets, asset protection should be a primary estate planning component. After all, taking the time to decide how you want your estate distributed after you are gone is only important if there is an estate left to distribute. While there are numerous estate planning tools and strategies that can help protect your assets, one common tool is an Intentionally Defective Grantor Trust (“IDGT”). Do not let the name fool you. There is a perfectly good reason for intentionally creating a defective trust. To help you understand, the Long Island asset protection planning attorneys at Eghrari Wealth Training Firm explain how an IDGT works and why you might want to include one in your estate plan.

Why Would I Intentionally Create a Defective Trust?

An IDGT is a specialized type of irrevocable trust. Typically, it is established to benefit the grantor’s spouse or descendants. The reason it is created as an irrevocable trust is to remove the trust assets from the grantor’s estate. A non-interested party is usually appointed to be the Trustee to avoid its accidental inclusion in the grantor’s estate.

The purpose of an IDGT is to freeze certain assets to avoid paying estate taxes on those assets; however, not freeze them for income tax purposes. A loophole allows the trustor to continue paying income taxes on certain trust assets because income tax laws will not recognize that those assets have been transferred away from the individual. This effectively allows the assets in the trust to grow tax-free and avoid gift taxation.

What Is Required to Establish an IDGT?

For the grantor to maintain income tax liability, the trust instrument must contain one trust provision from IRC sections 671–679, making it tax “effective” for estate tax purposes but tax “defective” for income tax purposes. This is the “defective” portion of the trust that triggers the need to pay income taxes and prevents the payment of estate taxes. For the trust to work as intended, it is crucial to understand the exceptions to the grantor trust provisions that could have the negative consequence of either losing the grantor trust status or causing the trust to be counted in the estate of the grantor.

How Is an IDGT Funded?

There are two ways in which you can fund an Intentionally Defective Grantor Trust. One is to make a completed gift to the trust while the other involves making an installment sale to the trust.

Making a completed gift is the most common way to fund an IDGT. The grantor makes an irrevocable, completed gift of the desired assets to the trust. Appreciating assets are frequently used because the income can be retained by the trust and passed to the beneficiaries. Moreover, additional transfer taxes are not paid on the asset even if it increases significantly in value. Be aware, however, that if the gift you make to an IDGT exceeds the annual exclusion amount for that year ($16,000 for 2022), the excess transfer will be considered a taxable gift that will reduce your lifetime exemption.

An installment sale results in the grantor receiving an interest-bearing promissory note payable by the trust. Because the IDGT is a grantor trust, no tax is due on any gain from the sale. The grantor keeps the ability to maintain an income stream from the installments, or the interest payments are made to the trust to grow the value of the trust corpus for the beneficiaries. If the value of the promissory note is equivalent to the value of the property sold, there is no gift tax liability.

Contact Long Island Asset Protection Planning Attorneys

For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns regarding the inclusion of an Intentionally Defective Grantor Trust into your estate plan, contact the Long Island asset protection planning attorneys at Eghrari Wealth Training Firm by calling us at 631-265-0599 to schedule your appointment.

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About Eghrari Wealth Training Law Firm

Mark S. Eghrari is an attorney in private practice in Smithtown, New York. He has been in practice since 1988. Mark S. Eghrari provides extensive estate and tax planning services to individuals and businesses. Mr. Eghrari’s primary focus is helping clients avoid probate, minimize or eliminate Federal and State Estate taxes and protect their assets from the high cost of nursing care, if they become ill.