How an intentionally defective grantor trust works
If you own a business or other assets that are still growing, an IDGT is a way to pass them to your children at a discounted value — while you keep paying the income tax on them, which quietly moves even more to your family, tax-free.
These are the questions that matter most when you’re looking at an IDGT.
What is an IDGT?
An IDGT is an irrevocable trust with a deliberate twist. It is written so that you keep paying the income tax on what the trust earns, but the assets you put into it are treated as outside your estate. In plain terms: you move a growing asset out of your estate for estate-tax purposes, but you keep paying its income tax — and that tax payment is itself a tax-free gift to your family.
For income tax
You still pay it
The IRS treats you as the owner, so the trust’s earnings are taxed to you personally. That is the intentional “defect” — and paying that tax is not counted as a gift.
For estate tax
The assets are out of your estate
The trust — not you — owns the assets, so their future growth is not counted in your estate when you die.
Why is it called “defective”?
The name sounds like a warning, but the “defect” is the whole point. The trust is intentionally written so that, for income tax only, the IRS still treats you as the owner. So you keep paying the income tax on the trust’s earnings — and because the law does not treat that tax payment as a gift, you are quietly moving more wealth to your family every year without using any of your gift-tax exemption.
Keeping the asset until death
Taxed in your estate
- The full value, plus all of its growth, is counted in your estate
- Estate tax can apply to everything above the exemption
- Your family may have to pay that tax in cash within months
Moving it to an IDGT
Out of your estate
- The asset and its future growth sit outside your estate
- You keep paying its income tax — a tax-free gift each year
- More passes to your family at a lower overall tax cost
How does selling assets to it work?
The IDGT does its most powerful work through a sale. Instead of giving the asset away, you sell it to the trust in exchange for a promissory note — a written promise that the trust will pay you back over time, with interest. Here is the sequence.
The steps of a sale to an IDGT
- You make a small “seed” gift to the trust first — often about 10 percent of what you plan to sell — so the trust has real value of its own.
- You sell the appreciating asset, often a discounted interest in your business, to the trust for a promissory note at the IRS’s minimum interest rate.
- Because the trust is treated as you for income tax, the sale creates no capital gains tax.
- The sale is at fair value in exchange for the note, so there is no gift tax on it — apart from the small seed gift.
- All the growth above the note’s interest rate stays inside the trust — outside your estate.
- You keep paying the income tax on the trust’s earnings, passing still more to your family tax-free.
Without an IDGT
James keeps the building
James Caldwell, a surgeon in Biloxi, owns the medical-office building his practice operates in, and it keeps climbing in value. If he holds it until death, its full value — and all of that growth — is counted in his estate, and his family could owe estate tax on it in cash.
With an IDGT
James sells it to the trust
James sells the building to an IDGT for a note. The rent pays the note, while all the future growth builds up inside the trust for his children — outside his estate. James keeps paying the income tax, moving even more to them, tax-free.
James and the Caldwell family are a composite example used to show how the planning works — not a real client.
Is an IDGT right for me?
Five short choices. Brent reads your answer back to you at the end.
A 30-second guided quiz. Get a personal read on whether an IDGT fits.
How Brent helps you
- Looks honestly at whether an IDGT’s tax savings justify its complexity for your family
- Coordinates the trust, the appraisal, and the promissory note so the structure holds up
- Works directly with your CPA and appraiser so the numbers line up from day one
- Builds in trustee and trust-protector provisions for the long life of the trust
