The Perks of IDGTs: How to Make the Most Out of Estate Tax Breaks for High Net-Worth Clients
A significant portion of many people’s wealth is derived from the property they own. But what happens if that wealth exceeds Connecticut’s Estate Tax exemption of $15 million (as of 2026)? Without proper planning, your estate could be liable for paying colossal estate taxes. For high-net-worth individuals, a well drafted Intentionally Defective Grantor Trust, or IDGT, can be a powerful tool in your Estate Planning toolbox. By finalizing the creation of an IDGT before your wealth surpasses the exemption amount, you can minimize the fiscal danger threatened by paying estate tax.
Imagine, for example, that you’re 55 years old with two beautiful beach-front properties in either Southport or Fairfield. Now imagine these properties, along with your miscellaneous brokerage accounts, equity interests, and retirement accounts, equate to about $11,000,000 (let’s assume $7,500,000 just between the two properties). Now, let’s assume that over the next 20 years, the value of your properties will double, bringing your total taxable estate to $18,500,000; well over the $15 million exemption. When confronted with a mixed federal & state estate tax of up to 50%, you could be looking at handing over more than $1,700,000 to the government!
What can be done to avoid this potential calamity? A skillfully drafted IDGT has the potential to save you from this tax disaster. The way a “defective” Trust works is by separating who owns an asset (let’s say the two homes) for income tax purposes and estate/gift tax purposes. Since the IDGT is irrevocable, once the Grantor transfers these properties to the trust, they technically no longer own them. But by incorporating certain powers, such as giving the Grantor the power of substitution, the Internal Revenue Code will treat the homes as if you own them, but only for income tax purposes. By transferring these homes to the Trust, you will see three main benefits. First, the growth of these assets will occur outside of your Estate (because they are technically owned by the IDGT). Secondly, the assets within can appreciate at a quicker rate since they are unburdened by paying income tax (you will pay the income tax, not your trust). Lastly, by paying the income tax yourself, you’ll likely be taxed at a lower rate. As of this year, trusts are taxed at 37% as soon as they accrue more than $15,200 of income, while individuals don’t hit that rate until they bring home more than $609,351. By using a portion of your lifetime gift/estate tax exemption to transfer your property to your trust, the hypothetical growth of $7,500,000 remains outside of your taxable estate. So long as the other $2,500,000 didn’t appreciate past the exemption’s limit, you’ll forgo paying any estate tax!
Why does this work? Internal Revenue Code § 675 explains that “The Grantor shall be treated as the owner of any portion of a trust in respect of which…a power of administration is exercisable in a nonfiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity” including “a power to reacquire the trust corpus by substituting other property of an equivalent value.” Essentially, since the Grantor of the IDGT has the power to substitute assets within the Trust for something of equal worth, they are considered the owner of that portion of the Trust (in this scenario, the owner of the homes) for income tax purposes. Despite this power of substitution, the Trust still requires an independent Trustee, meaning that the Grantor does not have, pursuant to Internal Revenue Code § 2036(a), “(1) possession or enjoyment of, or the right to income from, the property, or (2) the right…to designate the persons who shall possess or enjoy the property or income therefrom.” By having the Grantor maintain this power of substitution but not having “possession or enjoyment” of the property or the right to “designate the persons who shall possess or enjoy”, they are able to avoid including the contents of their IDGT as part of their gross estate (so long as it is drafted without any other powers that may trigger this Internal Revenue Code § 2036 inclusion).
Regardless of whether you own property in Sasco Hill or not, most wealthy individuals will benefit from utilizing a knowledgeable Estate Planning Attorney to draft them a comprehensive Trust based Estate Plan. Beyond tax planning, an IDGT can protect your assets from creditors, lawsuits, and divorces. Since you are technically not the owner, your Trust will guard your wealth and provide you with peace of mind in the event you find yourself faced with the prospects of civil litigation or impending divorce.
Concerned about protecting your wealth and leaving a meaningful legacy? Book an appointment with Attorney Matthew Wiley today to ensure that your family will enjoy the fruits of your labor for generations. Call (475) 273-2875 to schedule a consultation with Wiley Law now!
