Top 3 Takeaways for Business Owners & High-Net-Worth Individuals
- A BDIT Protects Growing Assets and Minimizes Taxes
A Beneficiary Defective Irrevocable Trust moves appreciating assets out of your taxable estate, reducing estate tax exposure and protecting them from creditors. - You Keep Control While Gaining Protection
Unlike many other trusts, a BDIT allows you to remain both trustee and beneficiary, so you can still manage investments and access trust assets under defined standards. - Expert Legal Setup Is Essential
Because of the technical rules and IRS requirements involved, working with an experienced estate planning attorney is critical to ensure the BDIT functions properly and avoids costly mistakes.
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Appreciating assets such as business interests can pose a double risk for entrepreneurs or investors in terms of protecting their wealth and their legacy. The growth of such assets can put them at risk of exceeding their lifetime gift and estate tax exemption at a future date, but it may not be possible to transfer them as an outright gift at present. Additionally, such assets can be a tempting target for personal creditors or litigation. One possible strategy to mitigate these risks is a Beneficiary Defective Irrevocable Trust (BDIT), an irrevocable trust created by a third party for a specific beneficiary that allows them to move assets outside of their taxable estate while still retaining significant control over them.
How a BDIT Works
As a variation on Intentionally Defective Grantor Trusts (IDGT), BDITs share some features with that type of irrevocable trust. However, instead of the trust being created by the grantor, who then sells assets to the trust, it is created by a third party. Here’s how it works:
- A third party creates the BDIT: A third party such as a family member or a friend makes a $5,000 seed gift to the BDIT to create it. That person names the individual for whom it is established as both the beneficiary and trustee of the BDIT. Distributions from the trust to that individual are limited to an ascertainable standard (that is, they can be made for their health, education, maintenance, and support.) The individual is also granted a testamentary power of appointment, meaning that upon their death they can direct who receives the property of the trust.
- Powers granted to the beneficiary/trustee: The individual is granted certain powers by the BDIT that make it a grantor trust to them, which results in the BDIT being included in their federal taxable income. However, provisions that exclude the BDIT from the individual’s taxable estate and keep it from being subject to creditor claims are also included. In effect, the BDIT is the individual for income tax purposes but not for estate tax or creditor purposes, by design.
- The individual sells assets to the BDIT: The individual then sells assets to the BDIT in return for a promissory note (i.e., they are not gifted to the trust). Because the trust is only funded with a small sum, though, a third party must act as a guarantor for a minimum of ten percent of the sale price in exchange for a guarantee fee.
The individual administers the BDIT: Because the individual is the trustee as well as the beneficiary, they are able to invest, purchase, loan, and sell assets inside the BDIT, as well as making distributions subject to the trust’s distribution standards.
Why Create a BDIT?
A BDIT has certain advantages that can make it attractive in the right circumstances, including:
| Benefit | Description |
| Shift Appreciation and Reduce Estate Taxes | When appreciating assets are sold to a BDIT, they are removed from your taxable estate. This prevents future growth from being subject to estate taxes, helping you preserve more wealth for your heirs. |
| Maintain Control Over Your Assets | Unlike most irrevocable trusts, a BDIT allows you to serve as both trustee and beneficiary. You retain management control over trust investments and distributions, while still receiving the protection benefits of an irrevocable trust. |
| Potential Tax Discounts on Asset Transfers | Assets sold to a BDIT can be valued as if sold to an unrelated third party, allowing for potential valuation discounts for lack of marketability or minority interest. This can significantly reduce the taxable value of transferred assets. |
| Protect Assets from Creditors and Litigation | Assets inside a BDIT are legally separate from your personal estate. This structure shields your wealth from creditor claims or lawsuits, providing an additional layer of legal protection. |
Risks to Be Aware of with a BDIT
As with any advanced estate planning strategy, BDITs are not without disadvantages. Some to consider are:
- Administrative requirements: For the trust to function as intended, funding and management of the BDIT must be done according to strict technical rules. Expert legal guidance is strongly advised to avoid unintended tax consequences.
- Possible estate taxation on promissory notes: Assets are sold to a BDIT in exchange for a promissory note that the individual receives. If they have a taxable estate upon their death, that promissory note may be subject to estate taxes.
- Loss of step-up in basis: Assets held in the BDIT may not receive a step-up in basis for income tax purposes upon the individual’s death. The possible tax implications for future beneficiaries should be considered and examined before this strategy is implemented.
Lack of administrative guidance: Unlike other types of trusts used to mitigate estate taxation, such as Spousal Lifetime Access Trusts (SLATs) and Irrevocable Life Insurance Trusts (ILITs), less administrative guidance and fewer court decisions exist regarding the mechanics of BDITs.
Advanced Estate Planning Guidance for Asset Protection and Tax Minimization
When your situation requires far more than a basic trust to safeguard what you’ve built, you need sophisticated legal guidance to ensure that you can find an estate planning and asset protection solution with the right features to fit your needs. At Bridge Law LLP, our Trusts & Estates team’s expertise in both domestic and international estate planning gives us the depth of knowledge necessary to provide customized solutions for every scenario. To schedule your consultation, contact us here today.
FAQ Module
A BDIT is a type of irrevocable trust established by a third party that lets the beneficiary control and benefit from trust assets while keeping them out of their taxable estate and protected from creditors.
Entrepreneurs, investors, and high-net-worth individuals with appreciating assets—like business interests or real estate—often use BDITs to manage estate taxes and protect wealth while retaining control.
BDITs require strict legal and administrative compliance. Potential drawbacks include the lack of a step-up in basis for future heirs and possible estate taxation on the promissory note if not structured correctly.
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