Estate Planning
with Intentionally Defective
Irrevocable Trust
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Overview
• Intentionally Defective Irrevocable Trust (IDIT) Basics
• Sample IDIT Examples
• Generation Skipping Transfer Tax (GSTT) Planning
• Dynasty Trusts
This document is designed to provide introductory information on the subject matter. MetLife does not provide tax and legal advice. Clients should consult
their attorney and /or tax advisor before making financial investment or planning decisions.
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Intentionally Defective Irrevocable Trust Basics
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Intentionally Defective Irrevocable Trust
a/k/a Intentionally Defective Grantor Trust
a/k/a Grantor ILIT
a/k/a Defective Trust
a/k/a Intentionally Defective ILIT
• All refer to the same type of trust
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Intentionally Defective Irrevocable Trust Basics
• IDIT is an irrevocable trust
• Trust income & deductions flow through to grantor
• Transactions between grantor and IDIT are generally
ignored for income tax purposes (e.g. sale of assets
by a grantor to his or her IDIT)
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IDIT Basics
• Assets are generally intended to be sheltered from
inclusion in a grantor’s estate
• May be used to purchase & own single life or
survivorship coverage
Note: IDITs may be subject to increased scrutiny by IRS. Clients should speak with their own legal and tax advisor regarding further details.
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IDIT Basics: Grantor Trust Rules
• There are a number of different ways to make a trust
“defective” for income tax purposes
• Sample trust provisions include:
– Ability to use trust income to pay life insurance premiums on
the life of the grantor and/or the grantor’s spouse
– Ability to exchange property of equal value
• Death or termination of grantor trust status
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Intentionally Defective Irrevocable Trust Basics
• Included for Income Tax Purposes
• Excluded for Estate Tax Purposes
– This unique tax characteristic allows Grantor to pay
income tax at grantor’s marginal rate
– Possible estate freeze
– Can buy new or existing life insurance policies
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IDIT Basics: Considerations
• Typically used for lifetime sales of grantor’s property
(e.g. sometimes discounted property*) in exchange
for promissory note.
• Installment notes should reflect applicable federal
rates (AFR)
• Imperative to observe all formalities of the transaction
in an arms-length, business-like fashion or else the
transaction may not be respected by the IRS.
(See Pierre v. Commissioner, T.C. Memo. 2010-106 (May 13, 2010))
* Use of discounts, though legitimate where appropriate, is often the subject of IRS scrutiny. It is important to confer with your independent tax and legal
advisors regarding the use of this technique.
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IDIT Basics: Tax Considerations
In event of the grantor’s death while the note is
outstanding
• Estate tax: Remaining value of the note is includable.
• Income tax: Unclear. Some argue that income
associated with assets sale should be recognized
because the trust is no longer a grantor trust upon
death.
Clients should seek guidance from tax and legal advisors.
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IDIT Basics: Benefits
• Grantor’s payment of the trust income taxes increases
the growth of trust assets and reduces grantor’s estate
over time.
• Grantor’s payment of the trust income taxes is
generally not considered a taxable gift.
• IDIT can potentially remove significant asset
appreciation from estate taxation.
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IDIT Example
• Business owner and spouse gift cash and other assets
to their IDIT.
• Business owner later sells discounted S corporation
stock or family limited partnership units to IDIT for 10year note.
• IDIT uses part of annual IDIT cash flow to fund annual
interest costs and to purchase survivorship coverage.
• Appreciated IDIT assets and cash flow used to repay
note.
This example is hypothetical, actual results will vary. This presentation points to potential advantages available through valuation discounts of limited
partnership interest/ S corporation stock. The ability to take valuation discounts, though supported in various court decisions, is complex and will almost
certainly be scrutinized by the IRS. Any such discount should be determined by a qualified appraiser. Such issues serve to point out the importance of
seeking the guidance of professional tax and legal advisors.
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General Skipping Transfer Tax: Basics
• The GSTT is an additional transfer tax
• GSTT is in addition to gift or estate tax
• GSTT exemption
– $5.34 million in 2014
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GSTT Planning: Basics
• GSTT gifts to long-term trusts may pass more wealth
to future generations than outright gifts subject to
ongoing estate tax erosion
• Lifetime gifts sheltered by the GSTT exemption can be
leveraged using life insurance (e.g. dynasty trusts)
• Use a dynasty trust as a door opener or discuss with
existing IDIT clients during annual review
appointments
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GSTT Planning: Dynasty Trust Example 1
• Annual or lump sum gifts to trust sheltered by lifetime
gift exemption or by gift tax annual exclusions.
• Gifts fully sheltered by insured’s or couple’s use of
their GSTT exemption(s).
• Dynasty trust with a zero inclusion ratio.
• Dynasty trust purchases single life or survivorship
policy.
Examples are hypothetical. For illustrative purposes only.
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GSTT Planning: Dynasty Trust Example 2
• Client may use split-dollar to defer gift outlays
• Initial and ongoing gifts fully sheltered by GSTT
exemptions
• Single life or survivorship life coverage
This example is hypothetical. Actual results will vary.
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GSTT Planning: Dynasty Trust Considerations
• Most states have Rules Against Perpetuities
statutes that limit the duration of a trust.
• Trusts can be perpetual in South Dakota and certain
other jurisdictions.
• Rules are generally based on where the trust is
administered and not where the client actually lives.
• Importance of working with skilled trust officers and
experienced tax and legal advisors.
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GSTT Planning: IDIT
• Designing the dynasty trust as an IDIT
• Advanced tax planning technique
• Requires skilled tax and legal advisors
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GSTT Planning: IDIT Example
• Couple makes initial gift to dynasty trust covered by
remaining lifetime gift exemptions and GSTT
exemptions.
• Couple sells discounted LLC interests to dynasty
trust/IDIT for 10 year note setting forth AFR.
• Dynasty trust purchases 10 pay survivorship policy.
• Note repaid from other trust assets and cash flow.
Examples are hypothetical. For illustrative purposes only. Use of discounts, though legitimate where appropriate, is often the subject of IRS scrutiny.
Clients should confer with their independent tax and legal advisors regarding the use of this technique.
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MetLife Brand
• One of America’s largest financial companies with
roots as far back as 1863
• Serves over 90 of the top one hundred FORTUNE
500® companies
• Recognized as the Nation’s Largest Life Insurer**
**
Based on life insurance in-force. A.M. Best, January 2013
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Important Information
The information contained in this document is not intended to (and cannot) be used by
anyone to avoid IRS penalties. This document supports the promotion and marketing of
insurance or other financial products and services. Clients should seek advice based on their
particular circumstances from an independent tax advisor since any discussion of taxes is for
general informational purposes only and does not purport to be complete or cover every
situation.
MetLife, its agents, and representatives may not give legal, tax or accounting advice and this
document should not be construed as such. Clients should confer with their qualified legal, tax and
accounting advisors as appropriate.
BDVL23788 L0414371397 [0415]
© 2014 MetLife, Inc. PEANUTS 2014 Peanuts Worldwide
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