A well-crafted estate plan ensures your wealth reaches your intended beneficiaries—not the IRS. If you’re looking to transfer assets efficiently while retaining financial control, an Intentionally Defective Grantor Trust (IDGT) can be an effective tool.

This estate planning strategy allows the trust creator (the grantor) to pay income taxes on trust assets, thereby reducing their taxable estate over time. An IDGT separates income tax from estate tax in a way that benefits both the grantor and their heirs. By shifting assets into this trust, you can reduce estate tax exposure while still benefiting from income generated by those assets.

What Is an Intentionally Defective Grantor Trust (IDGT)?

An IDGT is a specialized irrevocable trust designed to separate income tax liability from estate tax inclusion. Although the trust is irrevocable, for income tax purposes, the IRS still treats the assets as if they belong to the grantor.

However, for estate and gift tax purposes, those assets are removed from the grantor’s taxable estate. This legal structure allows for continued income tax liability while minimizing estate tax obligations.

The “defective” label refers to the income tax treatment, which is intentionally structured to benefit long-term estate planning. By paying income taxes on the trust’s earnings, the grantor reduces their overall taxable estate, which can lead to significant savings for future generations.

Key Features of an IDGT

An IDGT’s power lies in its irrevocable nature and its dual tax treatment. Here’s what makes it a key component in sophisticated estate plans:

Irrevocable Structure

Once assets are transferred into an IDGT, the grantor relinquishes ownership and cannot reclaim them. This separation ensures those assets are removed from the grantor’s gross estate for estate tax purposes.

While the grantor retains income tax responsibilities, this setup offers a solid foundation for long-term asset protection and estate reduction.

Separation of Income and Estate Tax Obligations

One of the primary advantages of an IDGT is the clear division between estate tax and income tax liability. The grantor remains responsible for paying income taxes on trust-generated income, which prevents that income from being taxed at the trust level.

At the same time, because the assets are outside the grantor’s estate, any appreciation occurs free of estate taxes—an effective wealth transfer mechanism.

Tax Benefits of an IDGT

Strategic use of an IDGT can unlock significant tax advantages, particularly in estate and income tax planning.

Reducing Estate Taxes

By keeping assets out of the taxable estate, an IDGT helps minimize estate taxes. While the trust is irrevocable, it may include certain retained powers, such as the ability to substitute trust assets with others of equal value—adding flexibility without jeopardizing tax benefits.

Since the grantor pays income taxes on trust earnings, the value of their estate is further reduced, which in turn decreases the potential estate tax burden for their heirs.

Income Tax Responsibilities Stay with the Grantor

The grantor must pay income taxes on the trust’s earnings. Although this obligation may appear burdensome, it actually benefits the estate plan by preserving trust assets for beneficiaries.

Because trust income is reported on the grantor’s personal tax return, the assets inside the trust can grow unburdened by tax obligations, maximizing what eventually transfers to heirs.

Funding an IDGT

There are two common ways to fund an IDGT: gifting assets or selling assets to the trust. Both methods help move wealth out of the estate while managing tax impact.

Gifting Assets to the Trust

Gifting high-value assets—such as cash, stocks, or real estate—can shrink the taxable estate. However, gifts exceeding the annual exclusion limit may trigger gift tax liabilities. To qualify for the gift tax exclusion, Crummey powers are often used. These powers give beneficiaries a temporary right to withdraw contributions, transforming future interest gifts into present interest gifts.

With gifted assets growing outside the estate, the grantor reduces their estate tax exposure while maintaining income from those assets. This tactic also helps maximize the use of gift tax exemptions.

Selling Assets in Exchange for a Promissory Note

Alternatively, a grantor can sell assets to the trust in return for a promissory note. The trust repays this note with interest, based on the IRS-published Applicable Federal Rate (AFR), which varies by loan term.

These sales don’t trigger immediate gift taxes and are often structured over 10–20 years. This allows asset appreciation to occur outside the estate while keeping annual trust payments manageable. As a result, the grantor freezes the asset’s value in the estate while transferring growth to beneficiaries tax-efficiently.

Common Uses of IDGTs in Estate Planning

IDGTs are particularly useful in transferring appreciating assets and leveraging gift tax exemptions.

Transferring Appreciating Assets

Whether structured as a sale or a gift, transferring assets like real estate or stock into an IDGT lets them grow outside the estate. A properly valued sale avoids triggering gift taxes, while a gift uses part of the lifetime exemption.

This approach helps pass on growing assets while reducing tax exposure—ensuring more wealth reaches your beneficiaries.

Leveraging the Gift Tax Exemption

IDGTs are ideal for maximizing the federal gift tax exemption. In 2025, the annual exclusion is $19,000 per recipient. Gifting assets to an IDGT takes advantage of this threshold while moving asset appreciation outside the taxable estate.

Despite being irrevocable, some retained powers—such as the right to swap assets—give grantors ongoing control while preserving tax advantages.

Key Considerations and Potential Drawbacks

Before establishing an IDGT, it’s essential to consider the long-term implications and potential trade-offs.

Grantor’s Tax Obligations

The grantor is responsible for all income taxes on trust earnings. Though this may feel like a burden, it’s actually a key benefit: it further reduces the grantor’s taxable estate while preserving the trust’s growth potential.

Whether transferring assets by sale or gift, it’s critical to understand the impact on your lifetime gift tax exemption and overall estate plan.

Certain retained powers—such as the ability to substitute assets of equal value—allow some flexibility in managing the trust post-setup, but full revocation or modification is generally not allowed.

Irrevocable Nature of the Trust

An IDGT is irrevocable, meaning the grantor cannot reclaim assets once they’ve been transferred. While this ensures estate tax benefits, it also requires commitment. The trust will remain active for income tax purposes, with the grantor continuing to pay taxes on its earnings—even though the assets are no longer in their estate.

Understanding these limitations is essential to making an informed decision about whether an IDGT fits your long-term goals.

Conclusion

Thoughtful estate planning sets the foundation for generational wealth and long-term security. An Intentionally Defective Grantor Trust offers a unique opportunity to reduce estate tax exposure, preserve asset growth, and efficiently transfer wealth.

By leveraging the separation between income and estate taxes, IDGTs allow your assets to grow outside your taxable estate, maximizing the legacy you leave behind.

Given the potential for future tax law changes, now is a smart time to explore whether an IDGT aligns with your goals. Consult with a qualified estate planning advisor to tailor the strategy to your financial picture.

FAQs

1. What is an Intentionally Defective Grantor Trust (IDGT)?
   An IDGT is an irrevocable trust where the grantor remains responsible for income taxes but removes the assets from their taxable estate. It’s a powerful tool for minimizing estate taxes while maintaining income control.
2. How does an IDGT work for taxes?
   Assets in an IDGT grow outside the estate for estate tax purposes, while the grantor pays income taxes. This reduces the taxable estate and allows trust assets to grow tax-free for beneficiaries.
3. Can an IDGT help avoid capital gains tax?
   Not directly. Beneficiaries may still owe capital gains tax when trust assets are sold. The grantor pays income tax on earnings, but capital gains are assessed when assets are liquidated.
4. Are there benefits to gifting assets to an IDGT?
   Yes. Gifting reduces your taxable estate and lets appreciation occur outside it. However, large gifts may reduce your lifetime exemption or trigger gift tax.
5. When should I seek professional help setting up an IDGT?
   If you’re considering complex strategies like using credit shelter or generation-skipping trusts with an IDGT, consult an estate planning attorney or tax advisor.
6. Are there risks in creating an IDGT?
   Yes. Risks include the irrevocable nature of the trust, ongoing tax liabilities, and potential asset valuation disputes. Proper legal guidance can help mitigate these concerns.