Transferring wealth to future generations of a family, especially when the assets are significant, requires careful estate planning. Having an estate plan helps ensure your ༒property and money go to your beneficiaries ෴with minimal tax implications.

Different types of trusts can help accomplish estate planning goals and objectives, but transferring large sums of money or other assets into these trusts at once can trigger gift taxes. Although strategies like 澳洲幸运5开奖号码历史查询:sprinkling, 澳洲幸运5开奖号码历史查询:Crummey power, or 澳洲幸运5开奖号码历史查询:five-and-five power, may help, they are not always the most optimal solution.

One alternative may be to establish a special type of trust known as an 澳洲幸运5开奖号💧码历史查询:intentionally defective grantor trust (IDGT).

How an 🍎Intentionally Defective Grantor Trust (IDGT) Works

The IDGT is an 澳洲幸运5开奖号码历史查询:irrevocable trust that has been designed so that any assets or funds that are put into the trust are not taxable to the grantor for gift, estate, generation-skipping transfer tax, or trust purposes. However, the grantor of the trust must pay the income tax on any revenue generated by the assets in the trust. This feature is essentially what makes the trust “defective,” as all of the income, deductions, and/or credits that come from the trust must be reported on the grantor’s 澳洲幸运5开奖号码历史查询:Form 1040 as if they were their own. However, because the grantor must pay the taxes on all trust income annually, the assets in the trust are allowed to grow tax free, and thereby avoid 澳洲幸运5开奖号码历史查询:gift taxation to the grantor’s beneficiaries.

For all practical purposes, the trust is invisible to the 澳洲幸运5开奖号码历史查询:Internal Revenue Service (IRS). As long as the assets are sold at 澳洲幸运5开奖号码历史查询:fair market value, there will be no reportable gain, loss, or gift tax assessed on the sale. There will also be no income tax on any payments made to the grantor from a sale. But many grantors opt to convert their IDGTs into complex trusts, which allows the trust to pay its own taxes. This way, they do not have to pay them out of po🎉cket each year.

What Type of Assets Should Be Transferred Into an Intentionally Defective Grantor🍨 Trust?

While there are many different types of assets that may be used to fund a defective trust, limited partnership interests offer discounts from their face values that substantially increase the tax savings realized by their transfer.

For the purpose of the gift tax, 澳洲幸运5开奖号码历史查询:master limited partnership assets are not assessed at their fair market values, because limited partners have little or no control over the partnership or how it is run. Therefore, a valuation discount is given. Discounts are also given for private partnerships that have no liquid market. These discounts can be 35%–45% of the value of the partnership.

How to Transfer Assets Into the Trust

One common method to transfer assets into an IDGT involves combining a modest gift with an 澳洲幸运5开奖号码历史查询:installment sale. For example, the grantor may gi✅ft 10% of the asset's value into the trust, while the remaining 90% is sold to the trust on an installment basi❀s.

Example: Reducing Taxable Estate

Frank Newman, a wealthy widower, is 75 years old and has a gross estate valued at more than $20 million. About half of that is tied up in an illiquid limited partnership, while the rest is composed of stocks, bonds, cash, and real estate. Obviously, Frank will have a rather large 澳洲幸运5开奖号码历史查询:estate tax bill unless appropriate 🅺measures are taken. He would like to l🀅eave the bulk of his estate to his four children.

Therefore, Frank plans to take out a $5 million 澳洲幸运5开奖号码历史查询:universal life insurance policy on himself to cover the cost of estate taxes. The annual premiums for this policy will cost approximately $250,000 per year, but less than 30% ($72,000) of this cost ($18,000 annual gift tax exclusion for each child) will be covered by the gift tax exclusion. This means that $178,000 of the cost of the premium will be subject to gift tax each year. Of course, Frank could use a portion of his 澳洲幸运5开奖号码历史查询:unified credit exemption each year, but he has already established a 澳洲幸运5开奖号码历史查询:credit shelter trust arrangeꦺment that would be 🅺compromised by such a strategy.

However, by establishing an IDGT, Frank can gift 10% of his partnership assets into the trust at a valuation far below their actual worth. The total value of the partnership is $9.5 million, so $950,000 is gifted into the trust to begin with. But this gift will be valued at $570,000 after the 40% valuation discount is applied. Then, the remaining 90% of the partnership will make annual 澳洲幸运5开奖号码历史查询:distributions to the trust. These distributions will also receive the same discount, effectively lowering Frank’s taxable estate by $3.8 million. The trust will take the distribution, use it to make an interest payment to Frank, and cover the cost of the insurance premiums. If the🦩re is not en𝓀ough income to do this, then additional trust assets can be sold to make up for the shortfall.

Frank is now in a winning position regardless of whether he lives or di♈es. If the lat🦩ter occurs, then the trust will own both the policy and the partnership, thus shielding them from taxation. But if Frank lives, then he has achieved an additional income of at least $178,000 to pay his insurance premiums.

The Bottom Line

An intentionally defective grantor trust can be a valuable tool for transferring wealth from one generation to the next in a family without incurring high estate taxes. But they are complex and should be structured with the assistance of a qualified 澳洲幸运5开奖号码历史查询:accountant, 澳洲幸运5开奖号码历史查询:certified financial planner (CFP), or an 澳洲幸运5开奖号码历史查询:estate planning attorney.