There are a plethora of trust options and structures that exist to help you manage the transfer of your wealth to your beneficiaries while minimizing your tax liability. If it’s important to you to ensure that your loved ones are financially secure and cared for after you’re gone, using a trust is a fantastic way to achieve peace of mind. The intentionally defective grantor trust may be one you would want to consider in crafting your estate plan, especially if you can afford to pay income taxes on the assets you wish to place into the trust. Each of the estate planning attorneys at Battaglia, Ross, Dicus and McQuaid, P.A., possesses a thorough understanding of the variables of Florida law regarding trust creation and maintenance and will be happy to discuss with you what might be best for your situation.
What is an Intentionally Defective Grantor Trust?
A grantor trust is a type of trust that allows the grantor to retain some control over the assets placed in the trust. Grantor trust rules in the IRS’s internal revenue code spell out how grantor trusts should work and penalties for not following those rules. The purpose of creating trusts as part of your estate plan involves separating assets from your ownership by placing them within a trust in order to more tax-efficiently gift those assets to beneficiaries. However, sometimes grantors, also known as settlors or the person who sets up a trust, tried to retain too much control over the trust itself. An intentionally defective grantor trust is one which is structured in such a way that it triggers grantor trust rules causing a different set of regulations governing the handling of the assets in that trust for tax purposes.
How Does an Intentionally Defective Grantor Trust Work?
Essentially, the purpose of triggering the grantor trust rules is to force the settlor to pay the income taxes generated by the assets held within the trust. This might sound counter-intuitive for the settlor, but he gains a way out of needing to use a gift-tax exclusion in order to gift the assets to beneficiaries almost tax-free. The settlor is, in effect, paying the income taxes for his beneficiaries so they don’t have to.
This means that while some small degree of control is retained by the settlor, the assets held within the trust are no longer under the control of the settlor’s estate for estate tax purposes. Paying the income taxes is required by law by the settlor and the settlor now avoids any gift tax.
Is an Intentionally Defective Grantor Trust Irrevocable?
As an irrevocable trust, an intentionally defective grantor trust is one which cannot be changed after it is created. There are many types of irrevocable trusts and at their core, they all have the purpose of removing assets from being owned directly by your estate and in return, you can enjoy substantial tax benefits. However, it can be exceedingly difficult to attempt to change any of the terms of an irrevocable trust after its establishment. This is one reason why it’s important to consult with a skilled estate planning attorney regarding whether an intentionally defective grantor trust is the right option to build a solid foundation for your heirs.
Funding an Intentionally Defective Grantor Trust
If you decide an intentionally defective grantor trust is in your interests, you have two ways to add assets to it. You can either make a completed gift to the trust or fund the trust through an installment sale.
Making a completed gift to an intentionally defective grantor trust allows the settlor to put assets into the trust without being able to change the gift later, namely irrevocably gifting the assets. If the settlor has assets that are likely to increase in value, this may be a great option since the increasing assets can be held by the trust and passed to family members or named beneficiaries and avoid additional taxes on them. There are some exceptions to this, so to be sure it’s best to discuss your options with a professional estate planning attorney at Battaglia, Ross, Dicus and McQuaid, P.A.
If you don’t want to simply gift the assets, you could also use the installment sale method. This helps avoid problems with gift taxes by allowing the settlor to sell the assets to the trust. The settlor then receives an interest-bearing promissory note and is treated as if he sold something to himself. This is beneficial because the settlor can choose to take the interest as income or add that interest to the value of the trust.
Is There a Reason I Wouldn’t Want to Use an Intentionally Defective Grantor Trust?
While adding an intentionally defective grantor trust to your estate plan can be an effective way to pay-it-forward for your loved ones, you need to seriously consider whether you have the funds available to pay the income taxes that are generated by the assets in the trust far into the future. It is possible that as the assets appreciate, the taxes on that income may become too much of a financial burden. Finding yourself in that situation could cause the irrevocability of the trust to break down and may even cause the assets to again be included in the valuation of your estate.
Get the Most Expert Estate Planning Attorneys on Your Side Today!
The estate planning attorneys at Battaglia, Ross, Dicus and McQuaid, P.A. are specialists in any kind of estate planning situation. Trusts are a fantastic way to minimize the tax liability of your estate and beneficiaries after your passing and our estate planning attorneys are here to help with the realization of your wishes and your legacy. If an intentionally defective grantor trust is something you think could benefit you and your heirs, get in touch today and begin crafting a plan to safeguard your assets. Whatever your circumstances, we are here to advise, guide and clear the way for you to protect your loved ones’ financial future for years to come.
