Could you protect your assets using an IDGT?

With the Biden administration promising to raise taxes on the wealthy, many people of means are concerned that they or their families could end up paying more. Although President Biden refers to the target of his tax hike as “billionaires,” the tax bill could affect many people who are well off but not in the billionaire category.

That has a lot of people scrambling to gift their assets to their children now, while taxes are still comparatively low. Others are rethinking what they want to hold onto and what they want to give to the next generation.

Still others are considering pouring money into an intentionally defective grantor trust, or IDGT (rhymes with “widget”).

An IDGT allows investors to put assets into a trust where they pay annual taxes on any realized profits, dividends or interest income that is generated. Using installment sales, with promissory notes that may last a decade or more, the investor can move assets into the IDGT over time without triggering the gift tax or capital gains taxes.

This removes the assets from the investor’s estate, for estate tax purposes. When the investor dies, the trust goes on to their beneficiaries, who only pay tax on the distributions, not the assets themselves. This is true no matter how much the assets’ value has grown.

With that in mind, it’s important to know that President Biden’s proposal might levy a capital gains tax on those asset sales via promissory notes. However, the plan is not yet law and we don’t know whether it will even be passed.

What else does Biden’s proposal do?

According to Accounting Today, there is no plan to increase the federal estate tax rate of 40% or the income level at which the federal estate tax kicks in ($12 million for individuals, $23 million for married couples). However, those income levels are already expected to revert to less than half of their current level on Jan. 1, 2026.

However, Biden is proposing to close the step-up in basis loophole in the estate tax. This loophole has allowed beneficiaries to avoid capital gains taxes on the increased value in the investments held by a deceased person. The Biden proposal would limit the step-up in basis loophole to people with incomes of less than $1 million.

This will put pressure on taxpayers to plan for different ways to pass along their wealth.

If you are interested in using a trust to minimize your estate and gift tax burden, contact your business lawyer right away.