We Care

Grantor trusts: another effective tax minimization tool

In our last post, we took a look at Grantor Retained Annuity Trusts and their effectiveness as a vehicle for reducing estate and gift taxes. Unfortunately, this planning technique and a number of others may soon be rendered much less useful if president Obama’s recent budget proposal passes into law.

Another technique that may suffer from the potential law is the Intentionally Defective Grantor Trust (IDGT), often simply referred to as grantor trusts. With IDGTs, one makes strategic gifts or sales of property to a trust which is intentionally flawed to ensure that the individual continues paying income tax on the property, but not estate taxes.

Typically, a sale to a grantor trust will involve the grantor selling as asset with potential for appreciation at its fair market value to the trust in exchange for a note for some length of time at the applicable federal rate, which is currently extraordinarily low. This removes the asset’s future appreciation from the grantor’s estate. Sales between the grantor and the trust will not result in income tax, and the grantor will not have incurred any gift tax since the trust purchases the asset at its fair market value.

IDGTs are typically funded by a gift of at least 10 percent of the value of the property transferred into the trust. The purpose of the gift is that it provides protection against an IRS challenge that the transaction is actually a gift.

The basic strategy behind the IDGT is that the assets within the trust will appreciate faster than the applicable federal rate, with the remainder of the assets staying in the trust for the benefit of the beneficiaries.

To determine whether this technique may fit into your estate plan-and it can easily fit into many-it is necessary to speak with an experienced estate planning attorney who knows your financial and family situation and your goals.

Source: Forbes, “Estate and Gift Tax Considerations for 2012: IDGTs- And you Must Act Now,” Rob Clarfeld, February 22, 2012.