Intentionally Defective Grantor Trust (IDGT)
An irrevocable trust deliberately drafted so the grantor pays income tax on the trust's earnings while the assets themselves sit outside the taxable estate. The income-tax payment is effectively an additional tax-free gift that compounds inside the trust.
An Intentionally Defective Grantor Trust () is an irrevocable trust that is "defective" for federal income-tax purposes but fully effective for federal estate-tax purposes. The grantor retains a specific power — typically the power to substitute assets of equivalent value under IRC § 675(4)(C), or to borrow without adequate security — which triggers grantor-trust treatment under IRC §§ 671-679. That means the grantor pays income tax on trust earnings each year, even though the assets are legally owned by the trust.
Why would anyone want this? Because the tax payment is not a gift — it's the grantor's own liability — so every dollar of income tax the grantor pays is effectively a tax-free transfer to the trust beneficiaries. Combined with an installment sale of appreciating assets to the trust (a classic "sale to an IDGT" transaction), the technique lets a high-net-worth (HNW) family shift enormous future appreciation out of the taxable estate.
The sale-to-IDGT mechanic: the grantor gifts seed capital (typically 10% of the intended transfer), then sells additional assets to the trust in exchange for a promissory note at the applicable federal rate (AFR) under IRC § 1274. No capital gain is recognized on the sale (grantor-trust status means the grantor is selling to themselves for income-tax purposes), the trust pays the note over time, and all appreciation above the AFR escapes the grantor's estate.
Failure modes: inadequate seed capital (IRS may recharacterize the sale as a gift), dying before the note is paid off (installment note's remaining balance is in the gross estate), losing grantor-trust status mid-stream (unexpected income-tax liability for the trust), and state income-tax surprises (some states do not honor federal grantor-trust status).
Tagged 🔴 — the structure requires coordinated work from an estate-planning attorney, a CPA familiar with grantor-trust returns, and usually a qualified appraiser for the assets sold.
State-specific notes
Grantor-trust status is a federal income-tax concept. Assets in an IDGT are generally excluded from the grantor's federal gross estate (IRC § 2036 issues arise only if the grantor retains an income interest or control over enjoyment). Watch IRS Rev. Rul. 85-13 and subsequent authority for the no-gain-on-sale position.
Virginia conforms to federal grantor-trust treatment for state income-tax purposes — income flows through to the grantor's Virginia Form 760. No separate state-level defective-trust election required.
West Virginia generally conforms to federal grantor-trust treatment. Verify current guidance with the West Virginia State Tax Department before implementation.
IDGTs are a federal-tax construct (grantor status under IRC §§ 671-679 while being complete for § 2036 purposes) administered under the Alabama Uniform Trust Code (Ala. Code § 19-3B-101 et seq.). Alabama has no state-level enhancement. Alabama's flat 5% income tax flows to the grantor for state purposes so long as grantor-trust status holds federally.