An Intentionally Defective Grantor Trust (IDGT) is an advanced estate planning strategy used to transfer wealth to future generations while minimizing estate taxes.
Despite the unusual name, the “defect” is intentional — and beneficial.
An IDGT is structured so that:
- For income tax purposes, the grantor (the person who creates the trust) is still responsible for paying the trust’s income taxes.
- For estate tax purposes, the trust assets are removed from the grantor’s taxable estate.
This combination can create powerful tax advantages.
Why Is It Called “Intentionally Defective”?
The trust is drafted to include certain provisions that make it a “grantor trust” under IRS income tax rules.
This means:
- The trust does not pay its own income taxes.
- The grantor pays the income tax on trust earnings.
That’s the “defect” — but it’s intentional because it allows the trust assets to grow without being reduced by income tax payments.
How Does an IDGT Work?
Step 1: The Grantor Creates an Irrevocable Trust
The IDGT is irrevocable, meaning it generally cannot be changed after creation.
Step 2: The Grantor Transfers or Sells Assets to the Trust
Common assets include:
- Closely held business interests
- Investment portfolios
- Real estate
- Assets expected to appreciate significantly
Often, the grantor sells assets to the trust in exchange for a promissory note.
Step 3: The Trust Grows Outside the Grantor’s Estate
Because the trust is outside the grantor’s estate for estate tax purposes, future appreciation is not subject to estate tax when the grantor passes away.
Meanwhile, the grantor continues paying the income taxes, allowing trust assets to grow undiminished.
Why Would Someone Pay the Trust’s Taxes?
At first glance, paying taxes on assets you no longer own sounds counterintuitive.
However:
- The tax payments are not considered additional gifts.
- Paying the tax effectively allows further wealth transfer to beneficiaries.
- It reduces the grantor’s taxable estate even further.
This creates an additional estate tax reduction strategy.
Key Benefits of an IDGT
Estate Tax Reduction
Appreciation occurs outside the grantor’s estate.
Tax-Free Growth Within the Trust
Because the grantor pays the income taxes, the trust assets can grow more efficiently.
Freeze of Asset Value
When assets are sold to the trust, their value is effectively “frozen” for estate tax purposes, and future growth benefits heirs.
Asset Protection Potential
Depending on how structured, assets may receive protection from beneficiaries’ creditors.
Risks and Considerations
IDGTs are complex and not appropriate for everyone.
Potential considerations include:
- The trust is irrevocable.
- Accurate asset valuation is critical.
- The strategy requires careful compliance with IRS rules.
- The grantor must have sufficient liquidity to pay ongoing income taxes.
- Future tax law changes may impact effectiveness.
Professional legal and tax guidance is essential.
Who Typically Uses an IDGT?
IDGTs are most often used by:
- High-net-worth individuals
- Business owners planning succession
- Families seeking multi-generational wealth transfer
- Individuals with estates potentially subject to federal estate tax
They are generally unnecessary for modest estates.
The Bottom Line
An Intentionally Defective Grantor Trust (IDGT) is a sophisticated estate planning tool designed to transfer appreciating assets out of a taxable estate while allowing continued tax-efficient growth for beneficiaries.
While the strategy can be extremely powerful, it requires precise drafting and coordinated tax planning.
If you are exploring advanced estate tax planning options, discussing whether an IDGT fits into your long-term wealth strategy is an important next step.
