Intentional “Defect” May Make Sense

Sounds a little “counterintuitive,” right?  But who ever said that all tax code terminology was intended to make sense to the average bloke?

Anyway, our subject for today is a clever estate planning device known as an “intentionally defective grantor trust.”  Sounds like somebody might be making a mistake in creating such a critter, but not so.

An “intentionally defective grantor trust” (IDGT) is an irrevocable trust drafted in such a way as to cause the trust’s income to be taxable to the grantor (rather than the trust itself, hence the intentional defect concept) while assets transferred to the trust can be thereby removed from the grantor’s estate at the time of his death.

IDGTs can be attractive because the income is taxed to the grantor (and not at the higher trust tax rates) thus allowing the wealthy grantor to relieve his estate of even more shekels over time.

Obviously, IDGTs aren’t for everybody, but for folks whose wealth includes substantially appreciating assets, a sale to an IDGT will convert those appreciating assets into a fixed-yield non-appreciating asset:  a promissory note.  The appreciation on the assets will be removed from the taxpayer’s estate and thus escape transfer tax!

This can be a real winner in cases where the property sold to the IDGT is likely to appreciate faster than the rate of interest being paid back to the grantor on the promissory note.  When interest rates are as low as they are now, this device can have a powerful payoff.

And despite all of the recent whining by the IRS about the paltriness of their budgets, “Americans for Tax Reform” aren’t buying it.  In a recent article, ATR cites at least five reasons why IRS isn’t facing reality:

  • According to the National Taxpayer Advocate’s Annual Report to Congress, IRS can’t justify many of its spending decisions.  “The IRS lacks a principled basis for making the difficult resource allocation decisions necessitated by today’s tight budget environment,” says the Advocate.
  • IRS has repeatedly failed to compile legally required tax complexity reports, having done so just twice since 1998.  These reports to Congress are supposed to contain IRS’ specific recommendations on how to make the tax code easier to comply with, thus hopefully reducing IRS’ enforcement efforts.
  • IRS continues to use ancient technology to serve taxpayers, including some applications over 50 years old!  Even Koskinen has acknowledged that, “In regard to software, we still have applications that were running when John F. Kennedy was President.”
  • In the wake of the recent successful “hack” of IRS systems to the detriment of about 100,000 taxpayers, Koskinen also admitted that a possible reason for the hack was the failure of the agency to implement some 44 recommendations of auditors and overseers, which could have strengthened data protections.
  • Profligate spending habits by IRS, including recent revelations that IRS spends over 500,000 hours per year on “union activities” rather than devoting some or all of that dough to telephone responses to inquiring taxpayers.

CONSULT YOUR TAX ADVISOR – This article contains general information about various tax matters.  You should consult your CPA regarding the implications to your own particular situation.

Jeff Quinn, the author of this article, is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno.  He can be reached at 831-7288, and welcomes comments at jquinn@ashleyquinncpas.com.

Leave comment