Implied Death of the Intentionally Defective Grantor Trust (IDGT)?

In President Obama’s 2013 budget, he proposes to include a change to the estate and gift taxation of an Intentionally Defective Grantor Trust (IDGT) created by a decedent. An IDGT is created to remove the property from a grantor’s estate for estate tax purposes through a gift, but the property is still treated as the grantor’s asset for income tax purposes. Thus, the property will grow in value free from estate taxes and income tax, the latter of which is paid by the grantor.

IDGT status is acquired by giving the grantor certain rights. Common rights are the right to substitute assets of the trust or borrow from the trust without adequate security. If the grantor dies with such rights in an IDGT, these rights do not trigger the inclusion of the trust in the grantor’s estate. Further, a sale to an IDGT is ignored for income tax purposes and thus no gain is realized on the sale to the IDGT. A common estate planning tool is a sale to an IDGT of a business interest that will grow rapidly over the grantor’s life.

President Obama’s proposal provides that if a grantor has the above rights in a typical IDGT, then; (1) all assets would be included in the grantor’s gross estate at the grantor’s death; (2) any distributions from the IDGT to the grantor’s beneficiaries during the grantor’s life would be subject to gift tax; and (3) if the IDGT status is terminated during the grantor’s life then all assets would be subject to gift tax. The proposal will effectively eliminate the IDGT. There is good news: (1) the proposal is not law and will not be up for vote to become law in the near future and (2) the law will not be retroactive.

This proposal suggests there is a possibility that the IDGT will not be available in the future. Thus, you should discuss with your clients or your attorney the use of an IDGT to take advantage of the positive income and estate tax treatment while the possibility is available. Any laws limiting IDGT will not be retroactive, so what do you have to lose?