It feels like the last few decades have been an investing roller coaster. However, with markets hitting all-time highs in recent weeks, some investors may be rethinking their trusts. Planning for income taxes in addition to estate taxes can add an extra layer of complexity to estate planning and a Wall Street Journal article, “Rethinking Some Grantor Trusts,” [no longer available from source] highlights some of the benefits of an Intentionally Defective Grantor Trust, or IDGT.
One of the primary benefits of an IDGT is that it can remove assets from a grantor’s taxable estate. That may lower estate taxes owed by heirs while the grantor still remains liable for the income taxes on the trust assets. The intention is to avoid transferring on any income tax burden to beneficiaries.
However, with markets reaching all-time highs, trust assets are potentially generating some higher long-term capital gains. For the owners of some types of grantor trusts, that could mean more significant income tax bills. But some trusts contain provisions that basically allow the grantor to flip a switch to turn off the trust’s grantor status. That means the trust would pay its own income taxes from that point on.
But grantors can make that switch only once. After that, there’s no way to switch back and forth. Most estate planning and financial advisors suggest a good deal of consideration before making that decision. As the possibility of bigger and bigger tax bills grows, however, it may be something investors increasingly consider.
The decision whether to use a GRAT or IDGT will depend on a number of factors, including the age of the grantor, type of assets transferred to the trust, and the potential estate tax savings. Since assets transferred into both a GRAT (that last to the end of the term) and IDGT will often result in the heirs receiving these assets with a carry-over basis, a grantor must consider whether the potential estate tax savings will be greater than the potential capital gains tax paid by the heirs.
This type of planning requires working with an experienced estate planning attorney, often in coordination with your financial or tax professionals. If you’re looking into the benefits, take the time to consult an estate planning attorney and financial professional to get the best advice.
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Reference: Wall Street Journal (October 29, 2014) “Rethinking Some Grantor Trusts”