A key goal of estate planning for those with considerable assets is minimizing or avoiding estate taxes. This tax, which is currently levied on individual estates worth just over $13.6 million and above, can take a big chunk out of the wealth you want your family and other beneficiaries to share in after you’re gone.
There are a number of estate planning tools that can help decrease the taxable value of your estate while still preserving it for your beneficiaries. One of these is an intentionally defective grantor trust (IDGT). While the name may be off-putting, it shouldn’t scare you away from considering this resource.
How does an IDGT work?
By putting assets in an irrevocable IDGT, they aren’t subject to estate tax after the grantor (the person who sets up the trust) passes away. In the meantime, if these assets (for example, investment accounts, real estate or even a business) earn income, the grantor receives that and pays income tax on it. Further, there’s no capital gains tax on assets in an IDGT that appreciate.
People often name children and grandchildren as beneficiaries. The trust assets can amount to a nice nest egg for them because the grantor and their financial advisors have been able to manage and grow the assets over the years.
These trusts can be funded either by selling or gifting assets to them. Selling them is more common in part because gifting them can trigger gift taxes. However, it’s crucial to get legal and financial guidance on which is best for you.
What is “intentionally defective” about these trusts? As noted, the grantor legally doesn’t own the assets in the IDGT, but they’re responsible for paying taxes on the income they earn.
An important change to Pennsylvania law
Until recently, Pennsylvania was the only state where income from these trusts wasn’t treated the same way under state income tax rules as federal ones. That made things more complicated for grantors when they filed their income taxes. However, at the end of last year, Gov. Josh Shapiro signed a law that that makes the treatment the same as under federal tax law. It won’t apply, however, until Tax Year 2025.
This is just a brief overview of IDGTs. If you think one of these trusts would be right for you and your family, learn more about them and how they can help you fulfill your estate planning goals.
