Estate planning is crucial for managing wealth and ensuring that your assets are transferred to your loved ones in a smooth and tax-efficient way. For Texas residents, who often own a mix of valuable real estate, businesses, and other assets, it’s essential to explore advanced strategies tailored to their needs. One powerful tool is the Intentionally Defective Grantor Trust (IDGT). While the name might sound counterintuitive, this trust provides significant benefits for Texans when structured properly. Below, a Katy, TX business succession lawyer who has been with our firm since its founding in 2021 explores what an IDGT is and why it is particularly advantageous for those living in Texas in 2025.
What Is An Intentionally Defective Grantor Trust?
An IDGT is an irrevocable trust designed to separate the grantor’s assets from their estate for estate tax purposes while still treating the grantor as the owner for income tax purposes. This intentional “defect” in the trust’s design allows the grantor to pay income taxes on the trust’s earnings without those payments being considered additional gifts. By doing so, the grantor effectively reduces their taxable estate while preserving the trust’s assets for beneficiaries.
The key feature of an IDGT is its dual nature. On one hand, it removes assets from the grantor’s estate, helping to avoid estate taxes. On the other hand, it keeps the grantor liable for income taxes, which can be a strategic advantage when looking to transfer wealth. For Texans, this is particularly beneficial given the state’s significant property and business ownership patterns. It also has the benefit of securing your privacy.
How Does An IDGT Work?
- Funding The Trust: The grantor transfers assets into the IDGT, often using a gift. In 2025, the federal estate and gift tax exemption is $13.99 million per individual, allowing significant wealth to be transferred without incurring gift taxes.
- Selling Assets To The Trust: Many Texas residents, especially those owning ranches, oil and gas interests, or family businesses, use the IDGT to sell appreciating assets to the trust in exchange for a promissory note. This allows high-growth assets to appreciate inside the trust, outside of the grantor’s taxable estate.
- Tax Treatment: The “defect” comes from a specific provision in the trust document that ensures the grantor is treated as the owner for income tax purposes. This keeps the trust’s income tax obligations with the grantor while ensuring the trust remains a separate entity for estate tax purposes.
- Beneficiaries: The trust’s beneficiaries, often the grantor’s children or other family members, benefit from the trust’s growth and distributions without additional estate taxes.
Benefits Of An IDGT For Texas Residents In 2025
Using an IDGT as part of an estate plan can provide substantial benefits, particularly in 2025 when the federal estate tax exemption remains at $13.99 million per person. Here’s why it’s especially important for Texans:
1. Estate Tax Savings
For Texas families with large estates, such as those owning valuable properties, businesses, or mineral rights, estate taxes can be a significant concern. By transferring assets to an IDGT, the grantor can remove the value of those assets, along with any future appreciation, from their taxable estate. This strategy can result in significant savings, as federal estate taxes can reach up to 40%.
2. Income Tax Planning
The grantor’s responsibility for the trust’s income taxes allows the trust’s assets to grow without the burden of tax payments. For Texas residents, this is particularly beneficial for assets like real estate or businesses that are expected to appreciate substantially over time. The compounding effect of tax-free growth can create a lasting legacy for future generations.
3. Preserving Wealth For Texas Families
By leveraging the gift tax exemption and removing appreciating assets from their estate, grantors in Texas can pass more wealth to their families. High-growth assets, such as farmland, business interests, or energy-related investments, are particularly suited for this strategy because their value often increases significantly over time.
4. Flexibility In Trust Design
An IDGT can be tailored to meet the specific needs of Texas families. For example, the trust can include provisions to protect beneficiaries from creditors, manage oil and gas revenues, or ensure that ranching or business assets remain within the family.
5. Tax-Free Payments Of Income Taxes
When the grantor pays the income taxes on the trust’s behalf, it’s not considered a gift. This allows the grantor to further reduce their estate without using additional gift tax exemptions, effectively transferring more wealth to beneficiaries.
Practical Example For Texas Residents
Imagine a grantor, John, owns a family ranch in Texas valued at $10 million. He expects the ranch’s value to grow significantly due to increasing demand for land. In 2025, John creates an IDGT and sells the ranch to the trust for a promissory note. The value of the ranch and all future growth are now outside his taxable estate.
Over the next decade, the ranch’s value doubles to $20 million. Because the appreciation occurred inside the IDGT, the additional $10 million is not subject to estate taxes. Meanwhile, John’s payment of the trust’s income taxes further reduces his taxable estate without impacting the trust’s assets. For John’s family, this strategy preserves wealth while avoiding significant tax liabilities.
For Texans
While IDGTs offer numerous benefits, they require careful planning and consideration. Here are some factors for Texas residents to keep in mind:
- Professional Guidance: Setting up and maintaining an IDGT requires expertise from estate planning attorneys, accountants, and financial advisors familiar with Texas laws and assets.
- Irrevocability: Once assets are placed in an IDGT, the grantor generally cannot remove them. It’s crucial to carefully consider what assets to transfer.
- Texas-Specific Assets: Texans often own unique assets, like mineral rights, family ranches, or oil and gas interests. These require specialized planning to maximize the benefits of an IDGT.
For Texas residents, the Intentionally Defective Grantor Trust is a powerful tool to reduce estate taxes, preserve wealth, and ensure smooth transfers to future generations. By leveraging the $13.99 million estate tax exemption and using strategies like selling appreciating assets to the trust, Texans can maximize the benefits of this advanced planning technique.
If you’re a Texas resident considering an IDGT, consult with a qualified estate planning professional familiar with the unique needs of Texas families. So long as you are eighteen or older, you should have an estate plan. With proper planning, an IDGT can be a cornerstone of a successful estate plan that secures your legacy for future generations. Stuart Green Law, PLLC has been working on estate plans for families that protect their assets. We are licensed in Texas, Kentucky, Pennsylvania, and South Dakota, so contact us for help today.