“INTENTIONALLY DEFECTIVE” The term “intentionally defective” refers to the fact that an IDGT is structured to intentionally violate the “grantor trust” rules of the Internal Revenue Code and thus cause the trust income to be taxable to the grantor during the grantor’s life. The grantor trust rules were originally designed to prevent a high-bracket taxpayer from using trusts to shift income to a lower- bracket taxpayer. An intentional “violation” occurs when the grantor or a trustee (not the grantor) who is a non-adverse party retains certain powers or rights, such as:
• The power to control beneficial enjoyment of the trust.
• Certain administrative powers, such as the power to borrow from the trust or the power to remove assets from the trust and exchange them for assets of equal value.
• The power to revoke the trust in favor of the grantor.
• The power to use trust income to purchase life insurance on the life of the grantor and/ or the grantor’s spouse. CAUSING THE TRUST’S INCOME TO BE TAXABLE TO THE GRANTOR HAS SIGNIFICANT ADVANTAGES: Because the grantor pays the tax on trust income, the assets inside the trust effectively grow tax free. The federal income tax rates applicable to trusts are extremely high, compared to the tax rates applicable to individuals. In 2022, for example, a 37.0% marginal tax rate applies when taxable trust income reaches $13,450. In comparison, for an individual taxpayer using the Single filing status, the 37.0% marginal rate only applies when taxable income reaches $539,900.
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