Intentionally defective grantor trusts or IDGTs are used in estate planning to put a hold on specific assets. In effect, it freezes the assets for the purposes of estate tax, but the same does not apply to income tax. If you’re working on your estate plan in California, this may be a worthwhile option for you to consider.
Why would you want a trust that’s defective?
An IDGT is a specific type of grantor trust with a key feature: a loophole that is intentionally built in. This is there partly to ensure that the person who uses it still pays their income taxes.
There are several ways that an intentionally defective grantor trust can be utilized in trust litigation. One of the most common use cases for these grants is if the beneficiaries of the trust are your kids or grandkids and the income tax on the growth of their inherited assets has already been covered by the grantor.
The grantor doesn’t own the assets
The element of an IDGT that sets it apart from other grantor trusts is that grantors don’t retain ownership of the assets in their trust. Instead, they are taken out of the estate. However, the grantor will still pay income taxes for any money they make from the trust’s assets.
With intentionally defective grantor trusts, there isn’t any recognition of the capital gains. This makes it so the trust isn’t taxed if its assets appreciate. On the other hand, grantors still have to cover the income tax provided any income is generated from the trust.
Intentionally defective grantor trusts, commonly referred to as IDGTs, are tools used in estate planning that allow individuals to freeze particular assets for estate tax but not income tax purposes. The loophole in this trust allows the person to get income from these assets.