Blog post

Growing up, I could never understand the idiom “You can’t have your cake and eat it too.” That’s because the more logical alternative is “You can’t eat your cake and have it too,” which is obvious, since once it’s eaten, it’s gone! The phrase (similarly used by many cultures – German: “You can’t dance at two weddings,” Russian: “…sit in two chairs at the same time,” Yiddish: same as Russian, but swap in the words “one tuchus”) is used when referring to the need to make compromises between options that cannot be reconciled.

However, there is one delicious example of being able to eat one’s cake and still have it: the Intentionally Defective Irrevocable Trust or IDIT. We all know the non-tax benefits of using an Irrevocable Trust:

• The ability to have assets managed on behalf of heirs, post-death of the grantor, consistent with the grantor’s wishes
• The protection of those assets from creditors during and post-lifetime
• The avoidance of misuse by spendthrift beneficiaries

We also know the estate tax benefits for the Irrevocable Trust: all assets inside the trust escape the impact of estate taxes at the death of grantor.

However, it’s the income tax advantages inherent in the IDIT that make it one of the very few strategies that allows us to eat our cake and still have it. A properly drafted IDIT allows the following:

• Income Tax generated in the trust is the responsibility of the grantor and reported by the grantor on his/her personal tax return. Not only does this simplify administration of the trust, but it allows the grantor to benefit the trust (by paying its income tax) without having to use annual gift tax exclusions or lifetime exemption.

• Capital Gains Taxation is avoided on property bought from or sold to the trust by and between the trust and the grantor.

For the right family with the right circumstances, these allowances can be exceptional—which is why the Obama Administration has tried to stop us from dancing at two weddings at the same time. For the last eight years, the President’s budget proposal has contained language to eliminate this double advantage. This proposal has never seriously been considered by the current Congress, but there are signs that it is being keenly eyed by other branches of government. At this time, happily, the letter “O” remains out of IDIT. The “Intentionally Defective Irrevocable Obama Trust” just seems foolish. But, advisors should seriously consider acting sooner rather than later if this option makes sense for their clients.

‍

July 14, 2016