The IRS recently issued Revenue Ruling 2023-2, which has garnered a lot of media attention because of its implications on the treatment of assets that have been transferred into an irrevocable grantor trust. We have received calls from clients who are concerned that their careful estate planning has been undermined by this new ruling and their heirs will not benefit from a “step-up” in basis. This article seeks to clarify how the recent ruling affects estate planning.

 

Trusts are sophisticated estate planning tools. They have been utilized in estate planning for many years – to accomplish many different goals, one of which is the minimization or elimination of transfer or estate tax liability. After a trust is created, it is funded with assets, which may consist of real estate, valuable items, stocks, bonds, and other investments. These items have a “basis” for tax purposes which, generally speaking, is their cost including fees and commissions. These assets are sometimes referred to as the “principal.” Principal may increase or decrease in value over the course of time. An increase in its value is called “capital appreciation” or “capital gain.”

 

Section 1014 of the Internal Revenue Code generally provides that the “basis” of an asset that has increased in value between the time of purchase and the death of the owner, is the fair market value of the asset at the date of the owner’s death. This is called “step-up in basis” and is very advantageous in the calculation of capital gains tax when the asset is later sold. Capital gains tax is assessed on the appreciation in value of the asset from the time of purchase to the date of sale. The step-up in basis closes the gap and reduces or eliminates capital gains tax!

The new Revenue Ruling calls into question whether assets which have been transferred into an irrevocable grantor trust are eligible for this step-up in basis upon the death of the grantor. The IRS affirmed that, if the transfer of the asset into the trust constitutes a “completed gift,” as defined by the tax code, the asset will not qualify for a step-up in basis under Section 1014 upon the death of the grantor. This is what has caused the stir!

What the media has failed to headline is that there are many different types of irrevocable grantor trusts and that they are utilized for a variety of different reasons. Some grantor trusts are designed to remove assets from the estate of the grantor. If the assets no longer belong to the “owner” at death, if they would not be considered part of the owner’s taxable estate, the step-up in basis afforded by Section 1014 will not apply.

 

However, our Medicaid qualifying irrevocable trusts are designed to invoke Section 1014 of the tax code. The grantor retains control over the property transferred to the trust and can receive the income generated by it. Because a completed gift to the trust has not been made, as defined by the tax code, the asset remains in the estate of the grantor and receives the step-up in basis at the time of grantor’s death, minimizing capital gains taxes.

 

The key takeaway here is to consult with and retain qualified counsel who can assist and advise you as to your needs, based on your unique circumstances. If you believe Revenue Ruling 2023-2 might affect you, or you have concerns and would like to review your documents and ensure they provide the most robust protection for your financial needs, please give us a call and schedule a consultation.