Irrevocable Grantor Trusts | Revenue Ruling 2023-2 | OH IN KY

IRS Irrevocable Grantor Trust Changes Have Major Impact on Beneficiaries

Published on by Wendy Holloway in Estate Planning

IRS Irrevocable Grantor Trust Changes Have Major Impact on Beneficiaries

Irrevocable Grantor Trusts (IGTs) have long been a critical tool for estate planning and effectively achieving tax minimization on asset transfer, providing the tools necessary to avoid probate, transfer assets, conduct legacy planning, and ensure the minimization of federal estate taxes.

Currently, one of the most unsettled topics is how assets transferred to these trusts are to be treated for both estate and income tax purposes. The IRS has issued  Revenue Ruling 2023-2, which states that upon the grantor’s death, assets held in the trust are not eligible for step-up in basis treatment. This change may result in higher taxes for many beneficiaries.

What’s step-up in basis?

Step-up in basis allows the basis of an asset to be “stepped up” to the fair market value of the asset upon the grantor’s death. With this tax provision, those who inherit assets would have the benefit of the assets increasing to the date of death value or six months after death whichever is decided by the trustee.

Here’s an example: If the decedent purchased stock for $200 and it was worth $2,500 at the time of the death, the person who inherited it would likely receive the stepped-up basis of $2,500. This “step up” helps to curb any capital gains that might have occurred based on the original basis. Inherited assets, including stocks, bonds, and real estate, are included in the step-up in basis provision.

Assets in IGTs under Revenue Ruling 2023-2

The Ruling makes it clear that IGT assets are not eligible for a step-up in basis. When the assets are placed in the trust, they are no longer part of the grantor’s estate going through probate and possibly having to pay estate taxes. The justification of the ruling is that the assets were controlled by the grantor for income tax purposes during the lifetime of the grantor. Because of this, the assets are not eligible for a step-up in basis.

The ruling states that “the assets of an irrevocable grantor trust are not considered as acquired or passed from a decedent by bequest, devise, inheritance, or otherwise within the meaning of section 1014(b), and therefore section 1014(a) does not apply.” When the grantor passes, the inheritance under this ruling is not considered to be “passed” or “inherited” as other assets are. Revenue Ruling 2023-2 has confirmed the position of the IRS that completed gifts to grantor trusts are not eligible for a basis step-up under Section 1014 of the Code upon the death of the grantor.

We must remember that Revenue Rulings are not law and are not binding in Federal or Tax court. Most courts are giving deference to Revenue rulings however, rulings do not always have weight because they are set on the arguments of the specific parties before the court at that time.

Some experts do not believe this ruling is beyond reproof and will file a return and then an amended return to mitigate the penalties while anticipating changes in the law.

What does this mean for taxpayers who use irrevocable grantor trusts?

Taxpayers who have used IGTs as part of their estate planning strategies to limit their tax liability may want to approach planning in a different way. In recent years, families have used irrevocable trusts to keep assets protected from spend-down when working to qualify for certain long-term government benefits, including Medicaid and VA Aid and Attendance.

An irrevocable trust is designed to minimize estate taxes, protect assets, and maximize Social Security benefits. In this trust, the grantor does not retain the right to amend, alter or revoke the trust.

With this new ruling, it may be in the grantor’s best interest to have the assets be included in the taxable estate at death rather than an irrevocable trust, depending on the size of the estate and the state where the grantor lives. Assets can then be spared from spend-down while avoiding both estate taxes and capital gains taxes. However, if the grantor retains the right to substitute assets in the trust this type of trust could still be a valuable estate planning tool.

What’s a spend-down of assets?

To qualify for long-term care benefits from programs like Medicaid, taxpayers need to satisfy asset limits by spending them down to certain levels. Spending down assets can include making qualifying expenses on assisted living and long-term care in nursing homes, doctor visits, prescription expenses, expenses relating to help with personal care, and housing costs from rent or mortgage.

Irrevocable trusts can protect assets from having to go through the spend-down process to reach the levels necessary to gain assistance from certain programs like Medicaid. This can be important when facing long-term care expenses, which can currently run upwards of $10,000 per month.

Should taxpayers still set up irrevocable trusts?

With proper planning, assets in irrevocable trusts can be moved to the taxable estate upon the grantor’s passing to take advantage of the “step up”, which may work well for taxpayers whose estates fall within limits that exempt them from estate taxes.

Most estates will not be subject to federal estate taxes based on the current exemption. On a federal level, estates need to be worth over $12.92 million in 2023 per person to be subject to estate tax. However, limits vary widely depending on the state. Oregon’s exemption in 2023 was $1,000,000, while Connecticut’s is $12,920,000, aligning with the federal limit.

Revenue Ruling 2023-2 has been published, and barring deviations from the ruling by federal or tax courts beneficiaries may be forced to pay high capital gains tax. Again, one way this may be mitigated is by the grantor reserving the right to substitute assets, as well as proper estate planning which constantly adjusts to rulings or laws.

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Navigating the changing landscape of estate planning is complicated and will only prove trickier in the coming years. For taxpayers who are close to estate tax limits on a state or federal level, it’s important to consult with a qualified estate tax planning professional to determine the best path forward. If you have questions about the information outlined above or need assistance with an estate tax issue, we’re here to help, so contact us for a free consultation.


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