By: Mark Rhea, J.D., CPA- Senior Assistant Accountant

Since the passage of the Tax Cuts and Jobs Act much has been made of the fact that individuals can now exclude from taxation total lifetime gifts and estate assets of $11.18 million. This is certainly a fair amount of money to exclude for gift and estate tax purposes, but it is possible that it may not be enough for people who are growing a successful, closely-held family business or have high-appreciating, income producing assets. For people in these situations, transferring these assets to an intentionally defective grantor trust may be the best way to protect those appreciating assets from unnecessary gift and estate taxes.

Although perhaps poorly named, an intentionally defective grantor trust is “defective” because the grantor who transferred the assets to the trust is obligated to pay the income taxes on it rather than the trust or the beneficiaries. This is by design allowing the trust or its beneficiaries to not have to pay income tax on income generated in the trust.

If done properly, an intentionally defective grantor trust (“trust”) will allow a person to transfer an asset to the trust where the value of the asset can appreciate and grow without fear of it incurring any gift or estate taxes. The process starts by setting up a trust that allows whatever is transferred into the trust to be considered not part of the grantor’s estate but will permit any income generated by it to be taxed to the grantor. The taxing of income to the grantor is accomplished many times by the grantor retaining the power to substitute assets in the trust. The trust is then funded with seed money in order to give the trust some equity which will be reported on a federal gift tax return as a gift to the trust. The asset that will be transferred to the trust from the grantor will be properly valued at fair market value by an appraiser or valuation analyst and then sold to the trust by the grantor. The grantor will receive a note from the trust in the amount of the fair market value of the property with a market interest rate and terms of repayment. The amount of the note essentially “freezes” the value of the asset transferred to the trust as the value of the note will not appreciate. As the IRS recognizes that the grantor and the trust are the same for income tax purposes, no gain is reported on the sale of the asset to the trust.

Sound too good to be true? It almost was when the Obama Administration sought to close the loophole that allows this to occur. Fortunately, it still exists, but the fact that actions were sought to do away with these trusts should tell you that it may not be around forever and now is the time to act in order to lock in the positive effects of an intentionally defective grantor trust.

If you believe that your circumstances are such that you and your family may benefit from an intentionally defector grantor trust, do not hesitate to contact us. Even if it turns out that it is not the best avenue for you, we can suggest alternatives that are. At Holbrook & Manter, CPAs we stand ready to help with all your wealth planning needs.