An Intentionally Defective Grantor Trust (IDGT) is an estate‑planning tool designed to freeze the value of assets (usually an LLC or limited partnership interest) for estate tax purposes while allowing future growth to accumulate outside the grantor’s taxable estate. The “defect” is intentional: the trust is drafted so that the grantor is still treated as the owner for income tax, but not for estate and gift tax.
The most common strategy is a sale to the IDGT:
- The grantor creates a IDGT with power of substitution and seeds it with a small gift (often 10% of the sale value). For assets in the trust, trust has ownership, but grantor still pays income tax on all income the assets generate.
- The grantor sells non-voting units of a LLC to the trust, and get a promissory note in return.
- The trust pays for the asset using a promissory note with interest at the IRS’s minimum rate (the AFR). Note terms are
- Note will be fully paid in # of years, usually 9-15 years.
- Every year, trust does not pay any principal, only the interest.
- At the end of the term, trust pays all principal to grantor
This is essentially an estate freeze: the grantor’s estate only receives the fixed note payments, while all future appreciation shifts to the beneficiaries
Risk
if LLC sold to trust underperform after the sale, trust may struggle to pay interest/principal to grantor. Assets are returned to grantor and no estate tax benefit gained.
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