One of the primary goals of estate planning is to maximize the assets that will pass to your heirs while minimizing the tax liability of your estate. One particularly effective strategy for working toward that goal is referred to as an estate freeze technique. Estate freeze techniques have several important advantages over other estate planning strategies and work by removing from your estate those assets that are most likely to appreciate in value. This effectively freezes the value of the transferred assets for federal and state estate tax purposes, while removing the growth from your estate in a tax-advantaged manner.
One popular estate freeze technique involves the use of an intentionally defective grantor trust (IDGT). You can transfer assets to an IDGT via lifetime gifting or by selling assets to an IDGT during your life. These two strategies are among the best methods of shifting growth out of the estate with minimal gift and estate tax consequences.
An IDGT is an irrevocable trust structured to allow you to continue to own the assets of the trust for income tax purposes while making the trust the owner for federal and state estate tax purposes. The result is that you continue to pay the income taxes generated by the trust property, but the assets (and any subsequent appreciation) are no longer included in your estate for estate tax purposes.
This structure provides three major advantages. First, in the event that you sell appreciated assets to the IDGT, capital gains will not be recognized. When selling appreciated assets, you will effectively be able to defer any gain on the growth of the assets until the trust liquidates these assets at a later date, if at all.
The second major advantage is with respect to the payment of income taxes. Since you are considered the owner of the property in the trust for income tax purposes, any income generated by assets in the trust will be taxed to and paid by you. This also serves to further reduce the value of your estate for estate tax purposes.
The third major advantage of this strategy is that any future growth of the transferred assets occurs outside of your estate. That effectively freezes the value of the transferred assets for federal estate tax purposes.
Consider the case of a sale. You would typically make a seed gift to the IDGT using a portion of your estate and gift tax exemption. The seed gift is subsequently used to make a down payment on the purchase of appreciating assets that you would like to remove from your estate. The trust will use a promissory note to finance the balance of the purchase and make periodic payments of interest and principal back to you. No income tax consequences are recognized even as you provide an income stream back from the trust. The growth of the assets transferred to the trust is excluded from your estate for estate tax purposes.
The use of IDGTs is one of a number of effective estate freeze techniques, such as grantor-retained annuity trusts (GRATs), family limited partnerships (FLPs), and others. Each technique has advantages and disadvantages, and one may be more appropriate for a certain individual or set of circumstances. Discuss both the tax and nontax advantages of these strategies with your financial advisor, attorney, and tax professional.
Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.