Are IDGTs subject to state-level estate or inheritance taxes?

Irrevocable Domestic Grantor Trusts (IDGTs) are complex estate planning tools designed to remove assets from your taxable estate while still allowing you to benefit from those assets during your lifetime, but the question of whether they are subject to state-level estate or inheritance taxes is nuanced and depends heavily on the specific state’s laws and the trust’s structure.

What Happens to Assets in an IDGT at Death?

When assets are transferred into an IDGT, they are generally removed from the grantor’s taxable estate for federal estate tax purposes. However, state estate and inheritance taxes operate differently. Many states mirror the federal estate tax exemption, meaning estates below a certain value aren’t taxed at all. But some states have lower thresholds, or even no exemption at all. California, for instance, does not have a state-level estate or inheritance tax, which is beneficial for residents utilizing IDGTs. But if an individual moves to a state *with* such taxes, the assets within the IDGT could be subject to taxation at the state level upon their death. The key is determining whether the state considers the grantor to still have “control” over the assets, even though legally owned by the trust. This ‘control’ could trigger state taxation.

How Does California’s Lack of Estate Tax Affect IDGTs?

Because California doesn’t impose a state estate or inheritance tax, the primary benefit of using an IDGT for California residents centers on avoiding potential *future* federal estate taxes and maximizing the use of the federal estate tax exemption. As of 2024, the federal estate tax exemption is $13.61 million per individual, but this is scheduled to revert to approximately $6.2 million in 2026. An IDGT allows you to ‘freeze’ the value of assets now, avoiding estate tax on future appreciation. However, for those residing in states *with* such taxes, it’s crucial to understand the specific rules regarding grantor trusts.

What About Community Property and the Double Step-Up in Basis?

In California, community property—assets acquired during marriage—is owned equally by both spouses. This carries significant tax benefits, especially the “double step-up” in basis. When a spouse dies, the entire value of their share of the community property receives a step-up in basis to its fair market value on the date of death. This means the surviving spouse inherits the assets with a new, higher cost basis, reducing potential capital gains taxes when those assets are eventually sold. An IDGT can work *alongside* the community property rules, but it doesn’t directly change the step-up in basis. The assets held in the IDGT remain separate from the community property unless specifically designated otherwise.

A Story of Untangling Estate Complications

I recall a client, David, who moved to California from New York several years ago. He had established an IDGT in New York to hold a successful family business. He hadn’t updated his estate plan to reflect his new residency. When he passed away, his family faced a complicated situation. New York, his original state of residence, still considered him to have control over the trust assets, potentially triggering New York estate taxes. It took considerable legal work and navigating the laws of both states to restructure the trust and minimize the tax burden. A proactive update to his plan, recognizing his California residency, would have saved his family significant expense and stress. It was a reminder that estate planning isn’t a “one and done” process, but an ongoing process of review and adjustment.

A Well-Planned Estate, a Peaceful Transition

Conversely, I worked with Sarah, a resident of Corona, California, who meticulously planned her estate using an IDGT. She understood the benefits of removing assets from her estate while still maintaining some control during her lifetime. She regularly reviewed her plan with us to ensure it aligned with current tax laws and her personal circumstances. When she passed away, the transition was remarkably smooth. Because California has no estate or inheritance tax, her family avoided those taxes altogether. The IDGT functioned as intended, removing the assets from her taxable estate and providing for her beneficiaries without unnecessary complications. It was a testament to the power of proactive estate planning.

Remember, estate planning is complex, and the rules surrounding IDGTs can vary significantly depending on your state of residence. Consulting with an experienced estate planning attorney, like Steve Bliss, is essential to ensure your plan is tailored to your specific needs and circumstances.

Steven F. Bliss ESQ. can be reached at (951) 582-3800.