Is it Time to Reconsider an Intentionally Defective Grantor Trust?

By Daniel A. Perry, Esq.

As we navigate the COVID-19 pandemic and review legislation which has passed and is pending, one cannot help but debate whether an amendment to the Federal Estate and Gift Tax may be on the horizon.

The Federal Estate and Gift Tax is a tax which is levied upon assets which are transferred to the next generation during your lifetime or at death. Presently, the Federal Estate Tax has an exemption which stands at $11.58 million. What this means is that the first $11.58 million of assets transferred at death (including life insurance death benefits) are not subject to the Federal Estate Tax. However, any amount over $11.58 million is subject to the Federal Estate Tax, which carries a top tax rate of 40%.

In prior taxing regimes, when the Federal Estate Tax Exemption was much lower, many families sought to limit their tax liability though the use of Intentionally Defective Grantor Trusts. This is a trust and estate planning tool in which a trust is frozen for estate tax purposes, but not for income tax purposes. It is especially useful in situations in which a family has an asset which is expected to appreciate substantially over the period of several years.

Intentionally Defective Grantor Trust for Appreciating Assets

Let’s look at the following example:

John and Jane have an estate worth approximately $24 million. Under the current Federal Estate Tax Exemption, John and Jane would be able to utilize an exemption totaling $23.16 million from the Federal Estate Tax.

Approximately $5 million of their wealth is from ownership interests in a business partnership. However, it is anticipated that this business partnership interest will increase in value from $5 million to $15 million over the next ten years. John and Jane realize that this will cause their estate to increase from $24 million to $39 million, and potentially subject their estate to approximately $6 million in estate taxes.

John and Jane implement an Intentionally Defective Grantor Trust to hold their business partnership interests. This strategy freezes their business partnership interest at $5 million. Although the business partnership interests increase in value to $15 million, for estate tax purposes, the value remains at $5 million. This preserves their estate value at $24 million. As a result, John and Jane’s estate will owe approximately $283,400 in estate taxes as opposed to approximately $6 million in estate taxes.

The national debt has increased by more than $2.2 trillion as a result of the CARES Act, the Families First Coronavirus Relief Act, and a variety of other federal legislation. As a result, one cannot help but wonder if the estate tax will have a resurgence in 2021 due to the increased national debate.

If you have questions about estate and gift tax planning and whether an Intentionally Defective Grantor Trust might be the appropriate strategy for you and your family, please contact our office at (513) 241-0400 or use our contact form to schedule a time to discuss how we can help your family.

The attorneys at Aronoff, Rosen & Hunt, LPA are here to help you!