8872. How can an intentionally defective grantor trust be used in family business succession planning?Alexis Longrcline202015-07-22T17:29:00Z2015-07-22T17:29:00Z14162377Summit Business Media1952788148872. How can an intentionally defective grantor trust be used in family business succession planning?A trust structure called an intentionally defective grantor trust (IDGT) is another trust structure that can be used by a small business owner to transfer business interests to the next generation. In using this strategy, the business owner actually sells his interests in the business to the IDGT, naming his children or other heirs as beneficiaries of the trust. An IDGT is an irrevocable trust that is valid for estate tax purposes, but “defective” for income tax purposes. This means the business owner (as the grantor of the IDGT) is the owner of the IDGT for income-tax purposes, but is not treated as the owner of the IDGT for estate tax purposes. Since the business interests are sold to the IDGT, there are no gift taxes. Further, there are no capital gains taxes to the business owner because sales between a grantor and an IDGT are disregarded for income tax purposes. Typically, the business owner will structure the sale so that there is no down payment by the IDGT, annual interest payments are at the lowest rate permitted by the IRS, and a balloon principal payment is due in nine or more years. This technique is similar to a GRAT, but without the mortality risk. The value of the business is taken outside of the business owner’s estate for estate tax purposes, because future appreciation and interest are sheltered within the IDGT. The business owner’s estate is also reduced by the income and capital gains taxes he must pay on the IDGT’s income. In other words, the business owner is not taxed separately on the interest payments but instead is taxed on all of the capital gains and income realized by the IDGT. The taxes paid by the business owner on the IDGT’s income and capital gains are effectively tax-free gifts to the beneficiaries of the IDGT. The viability of IDGTs as wealth transfer vehicles is supported by the IRS inRev. Rul. 2008-22 2008-16 IRB (April 21, 2008) although in a somewhat different context. In the ruling, a grantor of an inter vivos trust retained the power, exercisable in a non fiduciary capacity, to acquire property held in the trust by substituting other property of equivalent value. The ruling provides that, for estate tax purposes, the substitution power will not, by itself, cause the value of the trust corpus to be includible in the grantor’s gross estate, provided the trustee has a fiduciary obligation (under the local law) to ensure the grantor’s compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value, and further provided that the substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries.