Since the exemption from the federal estate tax is currently $5,250,000, indexed for inflation, some may say that federal estate tax planning and estate tax preparation are dead. If the emphasis is on the federal estate “tax”, we would agree since most American families have an estate that does not exceed the federal exemption amount. Although we are focusing on the federal rules, let’s not forget that many states have a state exemption or inheritance tax that needs to be considered.
However, if one is making the argument that estate planning is dead, we do not agree. The focus on estate planning has always been to preserve the estate for loved ones or for philanthropic purposes. In other words, asset protection is and always has been the key to effective estate planning. Since we live in a litigious society, steps should be taken to protect our assets from creditors and predators.
One estate planning strategy is to use an asset protection trust. Without going into detail, a life insurance policy could be transferred to the trust or the trust is funded and thereafter purchases an asset from the grantor at an arm’s–length price on an installment basis. One variety of the asset protection trust is the Intentionally Defective Grantor Trust (IDGT). If you are wondering why a trust that is intentionally defective is an effective estate planning tool, you are raising a very good question. Generally, an IDGT is an irrevocable trust for the benefit of loved ones in which the grantor does not retain any income interest. The fact that the trustee is someone other than the grantor provides spendthrift protection because the grantor no longer has control over the asset. The difference between the income tax laws and estate tax laws presents this planning opportunity. The trust is intentionally made defective for income tax purposes, but not for estate tax purposes, resulting in the grantor continuing to report the income tax consequences relating to the transferred asset(s) on the grantor’s personal income tax return (as if the transfer had never taken been made), but the asset no longer is part of the grantor’s estate for estate tax purposes.
When creating an IDGT, it is important that competent tax counsel be used. The grantor needs to be ensured that the trust agreement language and the related transfer of the assets and the installment agreement terms comply with IRS rules and regulations. If you are not currently using an estate tax attorney, we will be glad to recommend one.
Since each individual’s tax situation is different, if you want to learn more about the IDGT and its gift tax consequences, the benefits of taxing the trust income to the grantor, the IRS’s substantiation and documentation requirements to properly structuring the trust, and the risks associated with this planning technique, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation.
You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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