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March 2005 Intentionally defective grantor trusts get IRS OK An IDGT allows trust property to be shifted out of a taxpayer’s estate while still taxing the grantor on the trust’s income Since it's something that seems easy to put off for another day, estate tax planning has never been a particularly popular topic. Besides, didn’t Congress do away with the estate tax a few years ago? The short answer: No. The federal estate tax was scaled back because of the 2001 Tax Act and is scheduled to be repealed completely in 2010. However, between now and then, it is still very much with us (with a current per-person exemption of $1.5 million that will rise to $3.5 million by 2009). Plus, unless Congress makes a change, the estate tax is scheduled to spring back to life in 2011, with a reduced $1 million exemption. The IRS recently released some important guidance concerning a helpful estate tax planning opportunity for the relatively well-to-do. However, before we discuss this new release, let’s cover some basic estate planning that should apply to nearly everyone. The Basics With the current federal estate tax exemption covering up to $1.5 million of property, single individuals and married couples who are U.S. citizens and own combined assets of no more than that amount may not need to do anything beyond the basics. They still need wills (to provide guardians for minor children and to direct the disposition of their assets), general powers of attorneys, and powers of attorneys for health care (in the event of a disability that prevents them from handling their own affairs), and perhaps a living will or directive to physician. But they probably don’t need sophisticated estate planning. The catch is that circumstances can change or be different than you think. You may have more estate taxable property than you anticipated (including life insurance or a large inheritance) or the federal estate tax exemption could drop back down to $1 million. Thus, for most people it makes sense to take one or two basic estate planning steps. Married couples should make sure that both spouses’ estates benefit from the federal estate exemption. Since Arizona is a community property state, a very effective way to avoid probate and maximize the use of both spouses’ exemptions is to form a revocable living trust. A revocable trust provides for an orderly continuation of your affairs after your death and avoids costly legal fees in case of incompetency, and it typically “pours over” to the trust any assets not in the trust at death. For single individuals and married couples alike, the next step normally is to make sure any significant life insurance policies are held in such a way as to keep the proceeds out of the insured’s estate (usually using an irrevocable life insurance trust). If it appears that you still have an estate tax liability, the next option may be one of a handful of more complex solutions, such as a family limited partnership or an intentionally defective grantor trust (IDGT). IDGT Intentionally defective grantor trusts get their name from the fact that they allow trust property to be shifted out of a taxpayer’s estate while still taxing the grantor of the trust on the income that the trust earns. It has always been assumed that, when the grantor paid the tax on this income, it wasn’t treated as a gift to the trust beneficiaries nor would it cause the trust’s property to be dragged back into the grantor’s estate. If it works, an IDGT allows grantors to shift property out of their estate and to their heirs without any gift or estate tax. It is no longer necessary to make the above assumption; the IRS recently approved this technique. As long as the trust doesn’t have an obligation to reimburse the grantor for the taxes paid, no negative gift or estate tax issues result when the grantor pays the tax. If an intentionally defective grantor trust might help you achieve your estate tax objectives, contact your Schmidt Westergard & Company tax professional for more information on how you can apply it to your situation. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |