If you own a business that keeps appreciating, every year of growth adds to your eventual estate tax. A well-established “estate freeze” technique can lock in today’s value and shift tomorrow’s growth to your heirs — often with little gift-tax cost.
The scenario. Marcus, 70, owned an income-producing business worth $50 million that was appreciating steadily. He wanted to freeze its value in his estate and shift growth to his heirs, but he’d already used much of his exemption. Without advanced planning, the business and its growth would remain in his estate, generating a massive eventual estate tax. He was unaware of a technique that could sell the business to a trust, freezing the value at today’s price in exchange for a note, while future growth accrues outside his estate.
The problems.
- An appreciating business locked in the taxable estate.
- Limited remaining exemption for further gifts.
- All future growth exposed to the 40% estate tax.
The planning solution.
The technique is an installment sale to an Intentionally Defective Grantor Trust (IDGT). The “intentionally defective” label is a term of art: the trust is outside your estate for estate-tax purposes but is treated as owned by you for income-tax purposes (a “grantor trust”). That split is what makes the strategy work.
Here’s the sequence:
1. Seed the trust. You first make a gift to the trust — commonly around 10% of the value of what will be sold — so the trust has real equity and the subsequent sale is respected as bona fide.
2. Sell the business to the trust in exchange for a promissory note at the IRS’s applicable federal rate (AFR). This freezes the value in your estate at today’s price: your estate now holds a fixed-value note rather than an appreciating business.
3. Future appreciation accrues inside the trust — outside your estate — passing to your heirs free of additional estate tax.
The income-tax “defect” delivers a bonus. Because you’re treated as the owner for income tax, you pay the trust’s income taxes out of your own funds. This isn’t a burden — it’s a feature: it lets the trust grow undiminished by taxes, and your payment of the trust’s tax is effectively an additional tax-free gift to your heirs that doesn’t use any exemption.
Several details make it robust: the note must carry adequate interest and be treated as a real loan with real payments; the seed gift supports the sale’s legitimacy; and the strategy is frequently combined with valuation discounts (e.g., selling discounted FLP/LLC interests) for even greater leverage. The IDGT sale is often compared to a GRAT, but it can be better suited to closely held businesses, can run for longer terms, and is generally more GST-friendly for dynasty planning.
Key takeaways.
- A sale to an IDGT freezes today’s value in your estate via a promissory note.
- All future appreciation accrues outside your estate, passing to heirs.
- You pay the trust’s income tax — a tax-free benefit that lets it grow undiminished.
Own a closely held, appreciating business? Ask whether a sale to a grantor trust can freeze the value now and shift the growth to your heirs.