IDGTs and GRATs (along with many other income, gift and estate planning strategies) came under attack in the Obama Administration’s Fiscal Year 2013 Revenue Proposals (the “Green Book”) which, if enacted into law, could essentially eliminate the use of IDGTs and greatly reduce the effectiveness and flexibility of GRATs. This latest, although not totally unexpected, development prompts me to continue to passionately stress that there may never be a better time to engage in sophisticated estate and gift planning than now.
The calm before the storm. That would be an accurate characterization of how 2012 is shaping up, especially when it comes to estate planning. Our regular readers will likely remember why.
Nevertheless, along with the estate and gift taxes, there are a few more laws to watch as they worm through Capitol Hill. As a result, 2012 may be the last truly advantageous year for certain trusts like Grantor Retained Annuity Trusts (GRATs) and a somewhat lesser known vehicle, the Intentionally Defective Grantor Trust (IDGT).
A recent Forbes article cast the spotlight on the IDGT, so I thought I’d do the same here.
An IDGT lives up to the name, or at least it does when formed properly. In essence, the trust is set up by a Grantor (i.e., the Trustmaker) who then sells assets to the trust in exchange for a note at a very low interest rate. This is not uncommon with many trusts, but since it’s defective it also places the interest rate burden back on the grantor. Result: The Grantor gets an initial market value on their sale, which is likely to be low, and then continues to pay for those assets. Sounds a little weird, but stick with me.
Here’s what the Grantor is betting: The asset sold is presently legitimately “undervalued” right now, but is expected to greatly increase in value if the economy returns to full swing. As a consequence, the undervalued asset appreciates at a greater rate than the very low interest rate and thereby locks that value into the trust for beneficiaries, and keeps that added value from ballooning the size of an estate instead. Moreover, since the assets were sold in the first place, the use of such a trust won’t waste the valuable lifetime gift tax exemption.
Not everyone likes this strategy, however.
The threat, at the moment, to GRATs and IDGTs is the most recent budget proposal put forward by President Obama. Accordingly, the seeds are thereby sown and we can only expect much more (negative) attention to be drawn to these estate planning tools in the future.
Reference: Forbes (February 22, 2012) “Estate and Gift Tax Considerations for 2012: IDGTs - And you Must Act Now!”