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Grantor trusts can help minimize estate, gift tax

Trusts can be a very valuable tool in estate planning, particularly with respect to estate and gift tax minimization. Various types of trusts can be established for this purpose, though the setup one chooses should be based on the particulars of their financial and family situation, as well as their goals.

One type of trust that may be a good option for many estates is an Intentionally Defective Grantor Trust (IDGT), sometimes simply called "grantor trust." With an IDGT, strategic gifts or sales of property are made to a trust which is purposely written up incorrectly in such a way that the individual will continue to pay income taxes on the property, but not estate taxes.

The basic idea with a grantor trust is to place in trust assets which will appreciate faster than a lower federal rate, while the rest of the assets remain in trust so as to benefit the beneficiaries.

To do this, a sale to a grantor trust typically involves the grantor selling an asset that has the potential for appreciation at fair market value. In exchange, a note for some length of time at the applicable federal rate will be received. That rate is currently very low. The transaction removes the future appreciation of the asset from the grantor's estate. In addition, sales between the grantor and the trust will not trigger income tax. Neither will the grantor incur gift tax, as the trust purchases the asset at fair market value.

Grantor trusts are one of a number of estate planning tools that can help minimize estate and gift taxes. Another technique is the grantor retained annuity trust (GRAT). In our next post, we'll look at this estate planning technique.

Source: Forbes, "Estate and Gift Tax Considerations for 2012: IDGTs-And you Must Act Now," Rob Clarfeld, February 22, 2012.

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