Definition
The term intentionally defective grantor trust refers to an estate planning tool that allows for the transfer of assets for estate purposes, but retention of income for tax purposes. Intentionally defective grantor trusts allow donors to take advantage of an inconsistency between estate and income tax laws.
Explanation
Intentionally defective grantor trusts (IDGT) are established by donors and structured such that they are subject to grantor trust requirements. These trusts are typically irrevocable, but allow the grantor to retain certain powers over the trust such that it is classified as a grantor trust.
There are two features of these trusts that result in their classification as an intentionally defective grantor trust:
The trust is irrevocable, and the grantor does not retain any powers that would cause the assets to be subject to estate taxes. In doing so, the grantor is able to lower their effective estate taxes.
The grantor retains certain rights, such that the trust is classified as a grantor trust. As such, the grantor is responsible for the payment of income taxes due on the growth of the assets or income generated by the trust.
IDGTs are used by wealthy individuals, allowing them to provide their children or grandchildren with a trust that is able to grow without reductions for income taxes, which are paid for directly by the grantor. This mechanism allows the grantor to provide beneficiaries with additional assets that are not subject to estate taxes.
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