An intentionally defective grantor trust (IDGT) is an irrevocable trust deliberately drafted to trigger the grantor trust rules, so that its assets sit outside the grantor’s taxable estate while its income is still taxed to the grantor personally.
In plain terms
The word “defective” is marketing inherited from a drafting error that turned out to be useful. Nothing is broken. The trust is built to fail one test on purpose — the income tax test — while passing the one that matters for wealth transfer. Assets leave the estate, growth accrues to the children, and the grantor keeps writing the tax checks. In practice this is the workhorse structure of American estate planning above roughly $20 million, and the main alternative to a GRAT.
How it works
The grantor creates an irrevocable trust and includes a power that triggers §§ 671–679 — usually the right to substitute assets of equivalent value — without including any power that would pull the assets back into the estate under §§ 2036 through 2038. The drafting line between those two sets of powers is the entire technical craft of the structure.
Then comes the transaction that does the work: an installment sale to the trust. The grantor first makes a gift of seed capital, conventionally around 10% of the intended purchase price, so the trust has genuine equity and the note is not treated as a disguised retained interest. The trust then buys an asset — closely held company shares, a family partnership interest, pre-IPO stock — from the grantor in exchange for a promissory note bearing interest at the applicable federal rate.
Because of Rev. Rul. 85-13, the sale is invisible for income tax: the grantor is selling to himself, so there is no capital gain and the note interest is not taxable income. Everything the asset earns above the note rate stays in the trust for the beneficiaries, having used none of the lifetime exemption. Interests in a family entity are frequently sold at a valuation discount for lack of marketability and control, which lowers the note further.
The numbers
- Hurdle rate, August 2026: the mid-term AFR of 4.35% annually for a note of three to nine years, per Rev. Rul. 2026-13. Short-term is 4.10%, long-term 4.92%.
- Comparison: a GRAT must beat the § 7520 rate of 5.20% in the same month — a materially higher bar.
- Conventional seed gift: ~10% of the sale price, drawn from the $15,000,000 lifetime exemption (2026).
- Estate tax rate on anything left behind: 40% above the exemption.
- Typical note term: 9 years, often interest-only with a balloon payment.
- Typical valuation discount claimed on family entity interests: 20%–40%, and a frequent audit target.
What people get wrong
That an IDGT is simply a better GRAT. It clears a lower interest hurdle, it can allocate GST exemption so the trust can run for generations, and it is not destroyed if the grantor dies during the term. But it carries risks a GRAT does not. A GRAT that underperforms costs only fees; an IDGT sale that underperforms leaves the trust owing a note it cannot service, and unwinding it can produce gift tax exposure. The seed-gift convention has no statutory support — it is practitioner folklore that the IRS has never blessed. And the valuation is the soft spot: overstate the discount and the transaction can be recharacterized years later, when the asset has appreciated and the arithmetic is far less forgiving.
Related
Read more: Trusts: How Wealth Is Held, Protected, and Passed On · Inheritance: The Transfer of Wealth Between Generations · Generational Wealth: How Long Fortunes Actually Last
See also: Grantor trust · Irrevocable trust · GRAT · Valuation discount · Estate tax exemption