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Intentionally Defective Grantor Trusts–What is It and Why Do I Want One?

How about transferring an asset to a trust so it will be removed from your estate and therefore not a taxable estate asset, but retaining enough “strings” to the asset so that any income taxation will be paid by yourself and this income tax payment (accumulated over the years to become significant) also reduces your taxable estate as well as being able to personally pay expenses that become income tax deductions? Sound interesting, then you may be interested in the Intentionally Defective Grantor Trust.

Considering historically with lower interest rates and a depressed stock market, the opportunity for Estate Planning to the Asset Transfer Department is high to pass on dramatic amounts of wealth to our children and grandchildren. If you are “bearish” and believe your assets will continue to decrease, this article may be of little interest to you; in the alternative, if you are “bullish” and believe your assets will increase in the future (or at least sometime in your lifetime) this could be the perfect time to investigate and activate some really great Estate Planning.

Clients who are interested in transferring assets to their children and or grandchildren would be wisely served to consider what is referred to as a sale or transfer to an “intentionally defective irrevocable trust”. This is a tax efficient procedure to minimize estate taxation and leverage gifts, also this procedure “locks-in” value for Estate and Gift Tax consideration while passing all future appreciation to your children and or grandchildren.

To fully appreciate this Estate Planning strategy, a client must recognize that the rules for Estate and Gift Taxation are not the same as the rules governing trusts for Income Taxation. This reality of two distinctly different sets of rules result in the creation of an Irrevocable Trust that is fully and effectively recognized as a separate entity for purposes of removing assets from the estate for Estate and Gift Tax purposes, and at the same time “defective” and therefore not recognized as removing assets by the creation of a separate entity for Income Tax purposes.

One method of creating a Defective Trust is to retain for the grantor (creator of the trust) the right to substitute assets in the trust for other assets of equal value. Alternatively, the grantor can provide in the trust agreement that an “independent party” be designated and given the right to mandate distribution of principal and or income to the trust ultimate beneficiaries. Utilizing this approach, the cost to the beneficiaries is that they will receive the carryover basis that the trust “inherited” when they effectuate a sale of the assets originally transferred to the trust entity.

This web site is designed for general information only and should not be construed to be formal legal advice of a formation of a lawyer/client relations


Tarta Law Firm NJSteven W. Tarta, Esq. brings more than 45 years of professional experience to his practice, with a sophisticated focus on Estate Tax Planning, Living Trusts and Elder Law.

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