Matthew S. Payne is a Chicago-based attorney with a 20-year record of success in civil litigation, real estate law and estate planning.

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Basics of intentionally defective grantor trusts

On Behalf of | Nov 3, 2022 | Estate Planning

Trusts are powerful, flexible estate planning tools that can be used to allow for passing assets outside of probate or designed to provide the grantor or beneficiaries with particular tax benefits. In Illinois, one type of trust that can be helpful for estate planning is the Intentionally Defective Grantor Trust, or IDGT. With an IDGT, the grantor’s assets can be frozen for purposes of estate taxes but he or she will continue to pay income taxes associated with asset growth. This allows for tax benefits to the beneficiaries when the grantor dies.

Grantor trusts and the IRS

The Internal Revenue Service has promulgated rules that dictate how grantor trusts are handled for tax purposes. In some circumstances, an irrevocable grantor trust may be treated the same as a revocable grantor trust. The play between the rules and the legal instruments has given rise to the Intentionally Defective Grantor Trust. With an IDGT, the grantor remains responsible for payment of income taxes on the growth of trust assets. Thus, the beneficiaries are not responsible for these taxes later.

IDGTs and estate taxes

For purposes of estate tax, the value of the grantor’s estate is lessened by the value of the assets transferred into the trust. Typically, as part of their estate planning, the grantor sells the assets to the trust by taking a promissory note in exchange for the assets. Thus the trust holds the assets and pays for them by the terms of the promissory note.

IDGT beneficiaries

Typically, the beneficiaries of an IDGT are children or grandchildren of the grantor. During the life of the grantor, the grantor pays income taxes on the growth of the assets. When the grantor dies, the beneficiaries receive the trust assets without having to worry about paying these income taxes on the asset growth. If properly structured, an IDGT can reduce the taxable value of their estate while locking in the value of the assets for the beneficiaries. These trusts can be an effective part of a comprehensive Illinois estate plan.