As the lawmakers were trying to reach a deal that would stop the country from going over the so-called fiscal cliff various proposals were presented. One of them would have negated the value of a popular estate planning device.
The legal device that we are referring to is the intentionally defective grantor trust. Fortunately, as it turned out the agreement that was reached did nothing to reduce the efficacy of IDGTs.
The name is going to get your attention right away because it raises an immediate question. Why in the world would anyone put in the time and effort to have a defective trust drawn up?
In fact these trusts are very useful tools for those who are looking for estate tax efficiency as they prepare assets for distribution to their heirs.
These are irrevocable trusts, so when you convey assets into an intentionally defective grantor trust you are removing these resources from your estate. This is going to reduce your estate tax burden.
That part of the trust is not in anyway defective. It is considered to be defective because there is an intentional flaw built in that requires the grantor (rather than the trust itself) to continue paying income taxes on ongoing trust earnings.
There is a reason why this is not all bad. If you created the trust for the benefit of your children you obviously want them to receive as much as possible. If you pay the taxes the trust does not have to carry this burden and it will grow more freely.
Plus, you are continually reducing the taxable value of your estate as you make these income tax payments.
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