IDGT
IDGT is an irrevocable trust intentionally structured to be 'defective' for income tax purposes (the grantor remains taxable on the trust's income) but effective for estate tax purposes (the trust assets are outside the grantor's estate). Used for sophisticated wealth-transfer planning.
The IDGT structure exploits asymmetries in the income-tax and estate-tax codes. Specific 'grantor trust' provisions in the income tax code (Sections 671-679) cause the grantor to be taxed on the trust's income even though the trust is irrevocable. Different rules in the estate tax code determine whether the trust is included in the grantor's estate. By structuring the trust to trigger the income-tax inclusion but avoid the estate-tax inclusion, the result is a trust where the grantor pays the income tax (effectively making additional tax-free gifts to the trust) while the trust assets grow outside the estate.
IDGTs are commonly used for installment sales of appreciating assets to the trust. The grantor sells assets (often discounted family limited partnership interests or QSBS-eligible stock) to the IDGT in exchange for an installment note. Because the trust is grantor for income tax purposes, the sale doesn't trigger capital gains. The trust pays the note over time from the income generated by the sold assets; meanwhile, the appreciation on the assets occurs inside the trust.
The Biden administration's 2021 budget proposals included provisions that would have severely restricted IDGT planning by making grantor-trust transfers fully taxable. The proposals did not pass, but practitioners assume similar proposals will resurface — making timing of IDGT planning a planning consideration in itself.
Synthetic UHNW IDGT scenarios should track: trust funding date, installment-note balance, principal amortization schedule, interest payments (taxed to the grantor as ordinary income but not deductible since grantor + trust are same income-tax entity), trust asset performance, and the resulting wealth-transfer outcome. Pre-sunset and post-sunset tax-law uncertainty should be reflected in scenario projections.
Common pitfalls
- Failing to charge appropriate AFR interest on the installment note — below-AFR interest creates additional gift-tax cost.
- Letting the trust default to non-grantor status (e.g., grantor renounces grantor power without proper substitution) — undoes the income-tax-payment-as-additional-gift mechanic.
- Forgetting that the grantor's income-tax payments on trust income are NOT taxable gifts (treated as the grantor's own tax obligation) — this is a feature, not a defect.
- Treating IDGT as immune to legislative change — proposed reform packages have repeatedly targeted the structure; planning should consider sunset risk.
Examples
Grantor sells $20M of family-LP interests (with 30% valuation discount → $14M tax value) to IDGT in exchange for a 9-year installment note at AFR. Income-tax effect: zero — grantor and IDGT are same income-tax entity. Estate-tax effect: $14M asset moved outside estate; future appreciation on the underlying assets occurs inside trust. Grantor continues to pay tax on the trust's income for 9 years, effectively making additional tax-free gifts equal to the tax payments.