What is IDGT (intentionally defective grantor trust)?
Minneapolis attorney Sally Grossman discusses intentionally defective grantor trusts.
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Phone: (612) 632-3007
An IDGT is an acronym for an Intentionally Defective Grantor Trust. And, it’s kind of a funny name because, really, the planner didn’t screw up and make a defective document. What happens is that you draft the document to try to qualify for Grantor Trust status. And, lots of times, you wouldn’t want Grantor Trust status, so it’s defective in the sense that you’re trying to qualify for a tax status that in other context might not be advantageous. But, in this one, it is. And, what it means is that the Grantor will continue to be taxed on all of the income of the Trust. But, that also means that if there are transactions, like sales that would normally generate capital gain during the Grantor’s life, they aren’t going to have income tax to that. So, it’s like a transaction with yourself, and from the government’s point of view, it’s a non-event. So, what happens is the Grantor sets up an irrevocable trust, does some funding – so maybe, about 10 percent of the value of the business to be sold goes into the trust. That’s a taxable gift. Then, the trust buys the business on a note and so it’s a way to get promissory note income to the Grantor. You get the business into the Trust for the benefit of the family. You can allocate generation skipping so you can plan, not just for your children, but for your grandchildren. And the notes, usually about a nine year note, provide income and can be prepaid at anytime. So eventually, you end up with the business over here and the Trust. You have the Grantor over here with a frozen asset – the value of the note. And everybody’s happy.