When business owners start thinking seriously about estate planning, one challenge comes up again and again. How do you move future growth to the next generation without giving up control today?
That question sometimes leads people to intentionally defective grantor trusts, or IDGTs. They come up frequently in online searches and AI-generated suggestions because, on paper, they seem to solve a very specific problem. In the right situation, they can work. But they are also one of the most complex tools in the estate planning toolbox, and they come with real tradeoffs that need to be understood before moving forward.
What an IDGT Is Designed to Do
An IDGT is typically used when you own a rapidly appreciating asset, most often a closely held business. The goal is to move the future growth of that asset out of your estate while retaining control of the business today.
In simple terms, the trust ends up owning the asset, but for income tax purposes, you are still treated as the owner. That combination creates both the benefit and the complexity.
From an estate tax perspective, future growth happens outside your estate. From an income tax perspective, you continue paying the taxes, which allows the trust assets to grow without being reduced by tax payments.
How the Structure Actually Works
Consider a simplified example. Assume your business is worth $10 million today.
You transfer non-voting interests in the business to an IDGT. Those interests typically qualify for valuation discounts due to lack of control and lack of marketability. The trust does not simply receive the business for free. Instead, it issues you a promissory note for the value transferred.
At the end of the transaction, the trust owns the business interests, and you own a note payable from the trust, often bearing interest at the applicable federal rate.
The key outcome is this: all future appreciation of the business happens inside the trust. If the business grows from $10 million to $50 million, that $40 million of growth belongs to the trust and ultimately your heirs, not your estate.
The Cash Flow Tradeoff
This is where the decision becomes more complicated.
The trust must service the note. That means the business must generate enough cash flow to make interest and principal payments to you. At the same time, because the trust is a grantor trust, you personally pay the income taxes on the trust’s earnings.
In effect, you are trading unlimited upside for a fixed return on the note, while also committing to cover the ongoing tax bill so that trust assets can compound.
This structure works best when two conditions are true. First, the business is expected to grow faster than the interest rate on the note. Second, you have sufficient liquidity outside the business to support your lifestyle and pay the taxes without relying on the transferred asset.
What Can Go Wrong
IDGTs tend to look very attractive in best-case scenarios. The real risk shows up when outcomes fall somewhere in the middle.
If business growth slows, the note still has to be paid. That can put pressure on cash flow. If your personal liquidity changes and you need more income, unwinding the structure can be difficult. While some trusts allow asset substitutions, those provisions add more complexity and require careful drafting and administration.
There is also valuation risk. Discounts must be defensible, and aggressive assumptions increase audit exposure. Once assets are transferred, you cannot simply reverse the decision if circumstances change.
Finally, paying taxes on a rapidly growing business can become burdensome. What feels manageable at one income level can look very different if the business scales faster than expected.
When an IDGT Can Make Sense
An IDGT can be effective when you have a high-growth business, strong confidence in long-term performance, and substantial assets outside the business to support cash flow and taxes. It requires comfort with complexity and a willingness to coordinate closely with legal, tax, and financial advisors over many years.
This is not a plug-and-play strategy. It is a long-term commitment that needs to fit within a broader financial and estate plan.
The Bigger Picture
Tools like IDGTs are powerful precisely because they are restrictive. They reward careful planning and punish shortcuts. Before implementing one, it is essential to model not just the upside, but the scenarios where growth slows, liquidity tightens, or priorities change.
Used thoughtfully, an IDGT can shift significant value to the next generation while preserving control today. Used casually, it can create stress in places you did not expect.
This post is adapted from a recent episode of the Scholar Wealth Podcast. For more perspective on estate planning strategies for business owners and transferring future growth, listen to the full podcast episode here.