What is an Intentionally Defective Grantor Trust (IDGT) and why is it called 'defective'?

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AcadiFi · Accepted Answer

An Intentionally Defective Grantor Trust (IDGT) is an irrevocable trust designed to be 'defective' for INCOME tax purposes (grantor pays income tax on trust income) while being EFFECTIVE for estate and gift tax purposes (trust assets are outside the grantor's estate). The word 'defective' refers to income tax treatment — the grantor intentionally triggers grantor trust status to keep paying income tax. Typical IDGT strategy for Reginald Achterberg, a founder with a $50M closely-held business: ```mermaid flowchart TD A[Grantor
Reginald] --> B[Seed Gift
$1M] B --> C[IDGT] A --> D[Installment Sale
$9M note 9%] D --> C C --> E[Business
Interest] E --> F[Appreciates
to $50M] A -.->|Pays tax
on IDGT income| G[Beneficiaries
Inherit] ``` Steps: (1) Reginald makes a $1M 'seed' gift to the IDGT — this uses $1M of lifetime exemption. (2) Reginald then SELLS $9M of business interests to the IDGT in exchange for a 9-year promissory note at the IRS AFR rate (say 4.5%). (3) Because the IDGT is a grantor trust, the sale has NO income tax consequences — you can't recognize gain selling to yourself. (4) Business appreciates to $50M; only the $9M note plus interest remains in Reginald's estate. The $41M appreciation escapes estate tax. (5) Reginald pays income tax on all IDGT income, shrinking his estate further while compounding trust assets. Benefits: massive leverage of $1M exemption into $41M estate tax savings. Risks: (1) IRS scrutiny of valuation discounts, (2) death before note is paid off includes the note in estate, (3) grantor outlives assumed growth. Proper appraisal and legal structure are essential.

What is an Intentionally Defective Grantor Trust (IDGT) and why is it called 'defective'?

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