Critical Analysis of His IDIOT® Trust
D. Weinberg, an attorney (licensed, not practicing) with more
than 30 years experience in
tax law and estate and business planning, is president of The
Weinberg Group, Inc., a Denver, Colorado planning
specializing in the design and funding of estate and business
continuity plans for successful families and businesses. Mr.
previously served as a tax attorney in the Office of Chief Counsel,
Internal Revenue Service, New York City, before joining the
Weinberg has developed a planning technique which he refers to
as the IDIOT® Trust. An IDIOT® Trust combines an Intentionally
Defective Irrevocable Trust (IDIT) with an Irrevocable Life Insurance
Trust (ILIT). The result is an Intentionally Defective irrevocable
Outstanding Trust an IDIOT® Trust.
Weinberg is a member of the Colorado, Minnesota and New York bars
and is a former Adjunct Professor at the University of Minnesota
Law School. He is a former chair of the Insurance Committee of
the Real Property, Probate and Trust Law Section of the American
Bar Association (ABA) and served as editor of its Insurance Counselor
Primer series from 1987-1995. Mr. Weinberg’s articles have been
published in the CLU Journal, the Journal of Taxation, Trusts
and Estates, and Probate & Property. He is the coauthor of The
Insured Stock Purchase Agreement and has lectured and conducted
seminars for many industry groups, including the ABA, American
Law Institute, Miami Estate Planning Institute, Practicing Law
Institute, Note Dame Estate Planning Institute, Southern California
Tax & Estate Planning Forum, Texas Bar Association Advanced Estate
Planning Course and the American Society of CLU & ChFC. IDIOT®
Trust is a registered trademark of The Weinberg Group, Inc. The
Interviewer is our executive editor, Myron Kove, Esq.
What is an IDIOT® Trust?
The IDIOT® Trust is an estate freeze technique which combines
an IDIT (Intentionally Defective Irrevocable Trust) with an ILIT
(Irrevocable Life Insurance Trust) to achieve significant estate
planning benefits. The result is an IDIOT® Trust (Intentionally
Defective Irrevocable Outstanding Trust). The Trust beneficiaries
are the grantor’s children with grandchildren (or lower generation)
as the remainder persons.
How does the IDIOT® Trust achieve an estate freeze?
The grantor creates an IDIOT® which, for income tax purposes,
is treated as a grantor trust so that there are no income tax
consequences to the trust or the grantor. The grantor also funds
the trust with a significant "seed money" gift. The grantor sells
property, reflecting appropriate valuation discounts, to the IDIOT®
Trust in exchange for a bona fide promissory note.
What are the income tax consequences of the sale?
Since the IDIOT® Trust is treated as a grantor trust, there are
no income tax consequences to the trust or the grantor. No gain
is recognized on the sale. The trust is not entitled to an interest
deduction and the grantor does not have any interest income. Also,
the grantor’s basis carries over to the Trust. The grantor will
be taxed on the net income of the IDIOT® Trust. The payment of
the income tax reduces the value of the grantor’s estate, without
there being a gift of the income tax to the Trust beneficiaries.
How is the estate freeze achieved?
At the grantor’s death, only the unpaid balance of the note, plus
accrued interest, is included in his or her estate. To the extent
the property owned by the IDIOT® Trust increases in value, none
of the post-sale appreciation is included in the grantor’s estate.
What type of property should be sold to the IDIOT® Trust?
Any type of property may be sold to the IDIOT® Trust, including
closely held regular C corporate stock, subchapter S stock, partnership
interests, marketable securities, and real estate, so long as
its appreciation potential is in excess of the interest paid on
What are the terms of the note?
The note should be for a term of years with a balloon payment
of the principal at the end of the term. The note pays only interest
during its term. The interest rate is fixed at the IRS Applicable
Federal Rate (AFR) at the time of the transaction.
Why not have installment payments of principal rather than
a balloon payment?
The reason a balloon payment of the principal amount of the note
is recommended is because the IDIOT® Trust will purchase life
insurance on the life of the grantor equal to the principal amount
of the note. Additionally, keeping the note outstanding until
death maximizes the estate freeze. If the note is still outstanding
at the grantor’s death, the death benefit will be used to pay
the note so that the trust does not have to use any of the purchased
What if the grantor lives beyond the due date of the note?
There are several possibilities. The term of the note may be extended
or the trust may pay the note in kind with the purchased assets
or there may be a partial payment and partial extension. If the
IDIOT® assets have increased in value, less than all the assets
need be used to pay the note, and no capital gain is recognized
because of the grantor trust rules. Further, the reacquired assets
receive a date of death step-up in basis since they will be included
in the grantor’s estate.
Why is the interest rate the same as the AFR?
The purpose of the AFR is to avoid any gift tax on the transfer.
Since the note will be in an amount equal to the discounted fair
market value of the transferred property, the general rule is
that fixing the interest rate at the AFR rate eliminates any gift
since the note is deemed to have a fair market value equal to
its face amount. Frazee, 98 TC 554 (1992); IRS Letter Ruling 9535026.
How is the life insurance purchase structured?
The IDIOT® Trust will purchase life insurance on the grantor’s
life which may be funded either under a split-dollar arrangement
with the grantor’s company (or perhaps with the grantor or spouse
under a "private" split dollar arrangement), or full premiums
can be paid out of Trust assets, depending on the Trust’s cash
If the Trust has adequate assets to purchase the note, why
is there a need for life insurance?
Under the grantor trust rules, there is a basis canyover on the
assets sold to the IDIOT® Trust. The Trust will not want to sell
assets since it has a iow basis and will incur substantial capital
gain on any sale. Further, the Trust assets may include a family
business which the Trust will want to retain. One of the benefits
of the IDIOT® Trust is to provide a succession plan for younger
family members to take over the family business.
use of life insurance avoids the need to sell Trust assets, while
at the same time providing a source to pay principal on the note
and liquidity for the estate to pay estate settlement costs (estate
taxes, administration expenses and debts), and preserving the
family business for the family.
What is the purpose of the "seed money" gift?
The seed money contribution to the Trust is designed to avoid
any estate tax problems.
What estate tax problems are you concerned about?
The concern is that if the sold assets are the only source for
paying the note, then it might be argued that the grantor made
a transfer with a retained life interest. Such a transfer is included
in the grantor’s estate under Code Sec. 2036. By contributing
seed money to the Trust, the debt to equity ratio is improved
so that it is less likely that the creditor/debtor relationship
will be ignored. There is a similar issue under Code Sec. 2702.
Is there any rule of thumb as to the amount of seed money that
We recommend to clients that the seed money equal at least ten
percent of the discounted value of the assets sold to the Trust.
If the discounted value of the sold assets is $1 million, then
the seed money should be $100,000.
Are there any gift tax consequences related to the transfer
of the seed money?
The transfer of the seed money to the Trust is a gift to the Trust
beneficiaries subject to gift tax, except to the extent of any
available unified credit. If any gift tax is actually due on the
transfer, payment of the tax reduces the grantor’s estate, assuming
the grantor lives for more than three years following the gift.
Are there any generation-skipping transfer benefits using an
Clients may achieve significant leverage by structuring the IDIOT®
Trust as a generation-skipping transfer (GST) trust, assuming
the grantor has sufficient GST exemptions available to cover the
seed money gift. Once the IDIOT® Trust is exempt from GST tax,
then none of the trust assets, including the life insurance death
benefit and the sold assets, will be subject to GST tax even though
skip persons, the grandchildren, are the remainder persons.
How does this treatment compare to a GRAT (grantor retained
annuity trust) or GRUT (grantor retained unitrust)?
With a GRAT or GRUT, the grantor retains an interest in the trust.
If the grantor dies during the term, the trust property is included
in the grantor’s estate. The GST exemption cannot be allocated
during this period, known as the estate tax inclusion period (ETIP).
Therefore, the GST exemption is not available to a GRAT or GRUT
until after the trust term. With the IDIOT® note, there is no
ETIP, and the GST exemption can be allocated to the Trust after
it is funded with the seed money. This will protect all future
appreciation in the Trust assets from any GST tax.
Do you have an example showing how the IDIOT® Trust compares
to other planning strategies, such as GRATs or ILITs?
I have prepared a chart (Death At Projected Life Expectancy) which
summarizes the relative performance of the IDIOT® Trust as compared
to six other strategies.
What are the assumptions used in the chart?
We are assuming that a 55 year old grantor has assets of $16,500,000
available for the plan. The grantor sells $15 million of business
assets, with a discounted value of $10,000,000, based on a qualified
appraisal, in exchange for a $10 million balloon note due in 15
years. The note pays interest only, at the AFR rate. The grantor
also makes a seed money gift to the IDIOT’® of $1 million on which
a gift tax of $500,000 is paid. The IDIOT® purchases a $10 million
life insurance policy on the life of the grantor. The chart assumes
that the grantor will live a normal life expectancy of 24 years
and reflects the financial results of the various planning strategies
at the grantor’s death at that time.
What are the assumptions for the other strategies?
The starting asset base for each strategy is the same so we have
an apples-to-apples comparison. Each strategy involves a different
approach because of the nature of the strategy. For example, the
IDIT is similar to the IDIOT® in that it involves a sale of assets
in exchange for a note, but there is no life insurance, while
the WIT is funded only with life insurance. The "do nothing" strategy
means that the grantor’s estate will pay estate tax on the entire
value of the estate in view of the absence of any planning. A
direct gift means that the grantor will pay gift tax on the value
of the transfer, while a GRAT involves payment of gift tax on
only the remainder interest. The private annuity involves the
payment of an annuity in exchange for the property and, if properly
structured, should be gift tax free
What do the values in the chart reflect?
The chart shows the value of the starting asset base, plus earnings
and appreciation. For example, with the IDIOT’ Trust, the starting
asset base is the $10 million (discounted) property sold to the
IDIOT,"’ plus $1 million of seed money, plus the $500,000 used
to pay taxes. At the end of 24 years the asset base has grown
in value to $60 million, plus $10 million of life insurance death
benefit. Included is the grantor’s net taxable estate since he
or she has received interest payments during the 15 year note
term, plus the balloon payment in the fifteenth year. After deducting
estate taxes, the IDIOT® Trust reflects a net amount to the heirs,
after 24 years, of almost $70 million.
The chart shows that the IDIOT® Trust performs beter than any
of the other strategies.
That’s correct. The reason is because of the leverage achieved
with funding the trust with life insurance. Funding the IDIOT®
Trust with life insurance combines the transfer tax leverage
of each of its constituent trusts (the IDIT and ILIT) into a
estate planning technique.
Nothing contained in this interview is to be considered
as the giving of investment, legal or tax advice. Each person is
responsible for consulting his or her own investment advisors, lawyers
and accountants concerning the plan or plans and the ideas and techniques