A provision in the Build Back Better Act threatens to paralyze many life insurance companies. The problem lies in the provision entitled “Special Rule for Grantor Trusts”. In many ways, it makes sense to do away with the gimmicks that clever planners have hatched over the years to use the 1% of anything that anyone finds objectionable. And I’m afraid it might blind her.
When you set up a trust there are rules that will result in it being included in your estate. There are other rules that will result in you being treated as the owner of the trust for income tax purposes. The effect of this BBB provision is to bring these rules together. If you are considered the owner for income tax purposes, the trust will be included in your estate.
Grantor’s trust rules came into effect at a time of much higher marginal rates (up to 91%), when trusts had the same rate table as individuals. As rates were lowered and the escrow table compressed, trusts became less useful as a tool for avoiding income taxes. However, the planners saw a way to use the income tax avoidance rules to avoid transfer taxes.
The writer would intentionally (intentionally) give a power (e.g. this power was called a “defect” because it meant that the income and expenses of the trust would be accounted for by the grantor’s individual return. Hence the term Intentionally Defective Grantor Trust (IDGT ).
The really funny thing was when the donors got upset when they had to tax a capital gain that was confiscated in a trust for their grandchildren. It seemed like a good idea when the lawyer told them about it, provided they understood, but it’s the poor tax advisor who has to explain it when it actually happens. There are other ways IDGTs can be used to play games, but that’s not what this piece is about.
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When the law passes, you won’t want to play IDGT games with new trusts as this will result in property being added to the testator’s estate. If you already have that kind of confidence, that’s fine. But you shouldn’t add it, otherwise part of it will be included in your estate.
The planners are probably already working on new gimmicks. As far as most IDGTs go, this change will serve the real purpose of the inheritance and gift tax system, which is to serve as an office job program for college graduates who are not entirely smart enough to be doctors or engineers. But there is a fairly common form of trust that I am concerned about.