# Intentionally Defective Grantor Trust (IDGT) in Estate Planning

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## What Is an Intentionally Defective Grantor Trust (IDGT)?

An Intentionally Defective Grantor Trust (IDGT) is an estate planning tool designed to help individuals manage the tax treatment of certain assets. The IDGT allows assets to be excluded from the grantor's estate for [estate tax](https://www.investopedia.com/terms/e/estatetax.asp) purposes, but it keeps the [income tax](https://www.investopedia.com/terms/i/incometax.asp) responsibilities with the grantor.

This dual treatment can be highly beneficial for reducing estate taxes while still ensuring that the individual continues to pay income taxes on the earnings generated by the [assets](https://www.investopedia.com/terms/a/asset.asp).

### Key Takeaways

*   An intentionally defective grantor trust (IDGT) allows a person to isolate certain trust assets to segregate income tax from estate tax treatment.
*   It is effectively a grantor trust with a purposeful flaw that ensures the individual continues to pay income taxes.
*   IDGTs are most often utilized when the trust beneficiaries are children or grandchildren where the grantor has paid income tax on the growth of assets they will inherit.

## Understanding Intentionally Defective Grantor Trusts (IDGTs) 

[Grantor trust rules](https://www.investopedia.com/terms/g/grantortrustrules.asp) outline certain conditions when an [irrevocable trust](https://www.investopedia.com/terms/i/irrevocabletrust.asp) can receive some of the same treatments as a [revocable trust](https://www.investopedia.com/terms/r/revocabletrust.asp) by the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp). These situations sometimes lead to the creation of what are known as intentionally defective grantor trusts (IDGTs).

In an IDGT, the grantor remains responsible for paying income taxes on any income generated by the trust. However, the assets in the trust are not considered part of the grantor's estate when they pass away. This allows individuals to transfer assets while reducing the estate tax burden, as the assets are "frozen" in value for estate tax purposes but continue to grow inside the trust.

### Estate Taxes

For estate tax purposes, the value of the grantor’s estate is reduced by the amount of the asset transfer. The individual will “sell” assets to the trust in exchange for a [promissory note](https://www.investopedia.com/terms/p/promissorynote.asp)—also called an installment note—of some length, such as 10 or 15 years.

The note will pay enough interest to classify the trust as above-market, but the [underlying assets](https://www.investopedia.com/terms/u/underlying-asset.asp) are expected to appreciate at a faster rate.

### Beneficiaries

The [beneficiaries](https://www.investopedia.com/terms/b/beneficiary.asp) of IDGTs are typically children or grandchildren who will receive assets that have been able to grow without reductions for income taxes, which the grantor has paid.

The IDGT can be an effective estate planning tool if appropriately structured, allowing a person to lower their [taxable estate](https://www.investopedia.com/terms/t/taxableestate.asp) while gifting assets to beneficiaries at a locked-in value.

The trust’s grantor can also reduce their taxable estate by paying income taxes on the trust assets, essentially gifting extra wealth to [beneficiaries](https://www.investopedia.com/terms/b/beneficiary.asp).

> **Important**
>
> Due to the complexity, an IDGT should be structured with the assistance of a qualified accountant, certified financial planner (CFP), or an estate planning attorney.

## Selling Assets to an IDGT

The structure of an IDGT allows the grantor to transfer assets to the trust either by gift or sale. Gifting an asset to an IDGT could trigger a gift tax, so the better alternative would be to sell the asset to the [trust](https://www.investopedia.com/terms/t/trust.asp). When assets are sold to an IDGT, there is no recognition of a [capital gain](https://www.investopedia.com/terms/c/capitalgain.asp), which means no taxes are owed.

This is ideal for removing highly appreciated assets from the estate. In most cases, the transaction is structured as a sale to the trust, to be paid for in the form of an installment note, payable over several years. The grantor receiving the loan payments can charge a [low rate of interest,](https://www.investopedia.com/terms/l/low-interest-rate-environment.asp) which is not recognized as taxable [interest](https://www.investopedia.com/terms/i/interest.asp) income.

However, the grantor is liable for any income that the IDGT earns. If the asset sold to the trust is income-producing, such as a [rental property](https://www.investopedia.com/articles/investing/090815/buying-your-first-investment-property-top-10-tips.asp) or a business, the income generated inside the trust is taxable to the grantor.

## What Makes a Grantor Trust Intentionally Defective?

Intentionally defective refers to the fact that the grantor no longer owns the assets in the trust—they are removed from the estate—but still pays income taxes on any income earned from the assets in the trust.

## How Are Intentionally Defective Grantor Trusts Taxed?

An IDGT is not taxed when assets are sold to the trust or if they appreciate in value. However, the grantor is responsible for paying income taxes on any income generated by the trust’s assets. The key feature is that the assets are removed from the estate for estate tax purposes, but the income generated from them remains taxable to the grantor.

## What Happens to an Intentionally Defective Grantor Trust When the Grantor Dies?

If there was an installment note, the principal and any accumulated interest are included in the grantor’s taxable estate. However, if the assets were sold into the IDGT, they are not included in the taxable estate and can be passed on to the beneficiaries.

## The Bottom Line

An Intentionally Defective Grantor Trust (IDGT) is an estate planning strategy designed to freeze certain assets for estate tax purposes while the grantor remains responsible for paying income taxes on any generated income. This unique structure allows individuals to reduce their estate tax liabilities while ensuring that their heirs benefit from assets that have [appreciated in value](https://www.investopedia.com/terms/a/appreciation.asp).

Given the complexities involved in establishing and managing an IDGT, it is essential to consult with estate planning professionals, including an accountant or attorney, to ensure the trust is structured effectively.