When creating trusts for estate-reduction purposes, nothing compares to the Intentionally Defective Grantor Trust. This type of trust is referred to by the acronym “IDGT.” Called by some as an I-D-G-T and others a word that rhymes with “digit,” the IDGT is an excellent tool for reducing the value of a taxable estate.
Now is the time to consider creating an IDGT, and here’s why.
On January 1, 2026, the gift and estate tax exemption amount per individual is scheduled to drop to approximately $7 million. With the exemption amount at $13.61 million in 2024 and climbing with inflation in 2025, the sudden drop in 2026 will leave many individuals and married couples with taxable estates.
Making lifetime gifts to an irrevocable trust, such as an IDGT, is a great way to reduce the value of an estate in order to minimize or avoid the payment of estate tax.
An IDGT contains terms that essentially remove any asset gifted to the trust from the estate of the grantor (the individual who creates the trust). However, the income tax attributable to the gifted asset will be paid by the grantor and not by the trust itself or its beneficiaries.
For example, if the gifted asset is a rental property, the income earned by the property will stay in the IDGT and be utilized pursuant to its terms. However, the tax attributable to the income will be paid by the grantor and not by the trust or its beneficiaries.
That “defect” (i.e., the grantor paying the income tax on an asset the grantor no longer owns) provides two benefits. First, if the income were taxed to the trust, it would owe tax at the highest personal income tax rate on income over $14,450, with the top rate at 37 percent. Chances are good that the grantor pays income tax at a lower rate than the trust would. Second, if the grantor pays the income tax rather than the IDGT, the grantor would not be making an additional gift that might otherwise have to be reported to the IRS. The payment of income tax on behalf of an IDGT is not a gift.
What about capital gains tax? An important feature of an IDGT is inclusion of the grantor’s power of substitution. By retaining that power, the grantor ensures the possibility of removing appreciated assets from the IDGT and substituting other assets, thereby providing another tax benefit to the beneficiaries. It works like this – were cash having a value equal to appreciated real property transferred into an IDGT and the property itself transferred out, the property would then be included in the grantor’s estate with the cost basis it had on the date of the gift of the property to the IDGT. At the grantor’s death, the property would receive a step up in basis for capital gains tax purposes under current law (i.e., all gain would be forgiven). The grantor’s beneficiaries would then receive an additional “gift” by having little or no capital gains tax to pay upon subsequent sale of the property.
