What makes a trust intentionally defective

A dynasty trust is an IDGT designed to last for multiple generations without being subject to estate tax at the death of a beneficiary. Most states have a rule against perpetuities that requires a trust to terminate and distribute assets no later than 21 years after the death of an individual who was alive at the time the trust was created. However, several jurisdictions Delaware, South Dakota and Nevada, for example have abolished the rule against perpetuities and, if formed in one of those states, a dynasty trust can benefit many generations.

IDGTs provide wealthy individuals with a powerful planning tool to aid in their effort to maximize assets for the next generation, minimize estate taxes and ensure that family assets remain protected.

Including a spouse as a beneficiary will increase the flexibility of the trust and allow for distributions to the beneficiary spouse in the event that non-trust assets become insufficient. Creating the trust in a state like Delaware, which has abolished the rule against perpetuities, enables families to transfer generational wealth without the imposition of estate taxes or the requirement that the trust terminate at any point.

A discussion with your legal, tax and investment advisors regarding whether the benefits of a customized IDGT might suit your specific situation is recommended. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available.

The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. This material is intended for Professional Clients only and no other person should act upon it.

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When a trust is not a grantor trust for income tax purposes, it means that the trust itself will be a separate income tax-paying entity, and will file its own tax return each year, paying tax at rates based on the trust income. Generally, trusts pay higher tax rates than individuals, as the threshold income levels for each tax bracket are much lower than individual tax rate threshold amounts. When a Grantor retains certain rights to a trust, however, she will be considered the owner of the trust for income tax purposes.

In addition, when the grantor pays the income tax owed by the trust, she is essentially making additional tax-free gifts to the trust.

When a grantor is considered an owner of the trust for income tax purposes, but has relinquished rights to the assets in the trust in a way that allows the grantor to not be considered the owner of the assets for estate tax purposes, this is called an Intentionally Defective Grantor Trust.

But the defect is intentional because, in this case, we want the grantor to be the income taxpayer. When the trust is created, the grantor determines the way in which trust distributions are made. The IDGT can preserve the family wealth by limiting distributions to a standard set by the Grantor or by the discretion of a carefully selected Trustee. Access to funds by the beneficiaries can be as limited or as broad in scope as the Grantor decides.

The assets owned by the IDGT are for the benefit of the beneficiaries, but are not their personal assets. The IDGT can serve as a partial substitute for a premarital agreement, preserving the trust assets as separate property to which the beneficiary has only limited access. Mom and dad may wish to create an IDGT for the benefit of all of their descendants. Then, when the survivor of mom and dad die, the trust splits into 3 separate pot trusts.

But this time, each pot trust is only for the child and his or her kids. The way in which the grantor decides to structure the trust will depend on his or her own unique family circumstances. The Grantor may wish to build safeguards into the trust to protect her beneficiaries from creditors, and to allow her trustee to protect the assets from misuse by a beneficiary whose judgment has become clouded by substance abuse, improper influences, or any other issues that would jeopardize the trust assets.

The trust may hold life insurance policies on the life of the Grantor, allowing the proceeds of the policy to pass safely in trust to her intended beneficiaries. See more ». This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies.

Click here to read more about how we use cookies. To embed, copy and paste the code into your website or blog:. The following is a discussion of various income tax issues related to transfers of assets to an IDGT: Will the transfer of encumbered assets result in taxable gain? Send Print Report. Wendel Rosen LLP. Published In: Charitable Donations. Estate Planning. Estate Tax.