The purpose of a Beneficiary Defective Inheritor’s Trust is to allow an individual with a federal estate tax problem to maintain control of the assets to the maximum extent allowed by law. The assets placed in a BDIT will not be included in the individuals tax estate when they pass away. This type of trust, as explained in the article “Special trust helps protect inheritance funds” from Times Reporter, is an excellent estate planning technique to consider when creating an estate plan.
This type of trust will be most beneficial to anyone having an estate tax issue upon their death. While the current tax exemption is $12,920,000, the exemption is expected to drop to $5 million to $6 million in 2026. The estate tax rate is 40% of any asset over those estate tax exemption amounts. The BDIT helps reduce the estate tax.
How does a BDIT work?
The BDIT is created by an independent settlor and a different independent person is named as trustee. The settlor executes the trust agreement and gives the trust a check for $5,000.
The person with the estate tax problem is the beneficiary of the trust and has the right to move the $5,000 from the trust.
As the result of the right to remove the $5,000 from the trust, the beneficiary is considered the owner of the trust assets for income tax purposes. However, not for estate tax purposes.
The trust also has a protector, an independent individual who has various responsibilities, including the right to remove and replace the trustee.
The BDIT allows the beneficiary as much control as they can have without including the assets in the beneficiary’s estate.
The beneficiary reports all income on the beneficiary’s individual 1040 tax return.
The beneficiary then sells assets—they could be stocks or units of a closely held business—in exchange for a promissory note. Thus, the BDIT owns the securities and/or the closely held business.
The BDIT then receives distributions from the business and in return, makes payments to the beneficiary on the promissory note.
The beneficiary continues to receive payments on the promissory note until the note is paid off. The promissory note is included in the beneficiary’s estate. By paying off the note, the assets in the individual’s estate are being reduced.
The BDIT also provides that the beneficiary is to receive income and principal for health, education, maintenance and support, so when the note is paid off, the individual still receives these payments from the BDIT.
On the death of the beneficiary, the contingent beneficiary can be the beneficiary’s descendants. The assets in the BDIT are never included in anyone’s taxable estate.
This is a somewhat complex estate planning technique and should be considered only after a thorough review of your unique situation with an advanced estate planning attorney.
Reference: Times Reporter (Jan. 8, 2023) “Special trust helps protect inheritance funds”