The IRS has recently issued guidance (Rev. Rul. 2023-2) denying a basis adjustment under Section 1014 for property acquired from a decedent when the property is held in a grantor trust upon the death of the grantor.
Grantor trusts are trusts that are separate legal entities that can hold property, but for income tax purposes, the assets and corresponding income are considered owned by the grantor of the trust. The trust assets may or may not be included in the grantor’s estate depending upon the facts and circ*mstances. For the purposes of this ruling, there are two types of grantor trusts:
- Grantor trusts included in the grantor’s estate for estate tax purposes (“traditional grantor trusts”)
- Grantor trusts not included in the grantor’s estate, sometimes referred to as intentionally defective grantor trusts (IDGTs)
In traditional grantor trusts, the grantor retains significant control over the assets, so that there is not a completed gift for gift tax purposes when the trust is established. This is most common when the grantor retains the right to revoke the trust. The trustee may hold the title to the property, but the grantor, by retaining the right to revoke the trust, has not relinquished dominion and control over the property and there is no completed gift when the grantor places assets in the trust.
In an IDGT, assets can be gifted or sold to the trust; however, because the grantor has retained an administrative power, such as the power to substitute property of the trust for property of an equal value, the trust is not considered a separate trust for income tax purposes. All of the income of the trust is taxed to the grantor, but the trust assets are not included in the grantor’s estate.
This ruling addressed a situation in which the grantor established an irrevocable trust, and the trust terms resulted in a completed gift for gift tax purposes. So, the trust assets were not included in the grantor’s estate, but the grantor retained a power that results in the income being taxed to the grantor for income tax purposes (i.e., an IDGT). The grantor subsequently died after the trust assets appreciated. The liabilities of the trust did not exceed the basis of the assets at the date of the decedent’s death and neither the trust nor the grantor held a note on which the other was an obligor. The issue of the ruling is whether the assets in the trust would receive a basis step up on the death of the grantor even though the trust assets were not includible in the grantor’s gross estate.
The ruling reviews the applicable statutes and case law and concludes that since the property in the trust would not be considered as having been acquired or passed from a decedent under Section 1014(a), or fall within any of the additional types of property listed in section 1014(b), there would be no basis adjustment under Section 1014 for the assets held in the trust. The ruling is limited in coverage factually to situations where the liabilities of the trust did not exceed the basis of the asset at the date of the decedent’s death and neither the trust nor the grantor held a note on which the other was an obligor.
Although not explicitly stated in the ruling, in the absence of the application of the fair market value adjustment of the basis provided for in Section 1014, the general rule of Section 1015 would apply. Section 1015 generally provides for a carryover basis for direct gifts from a grantor and for transfers in trust.
As a seasoned expert in tax law and estate planning, I bring a wealth of knowledge and experience to shed light on the recent IRS guidance issued in Revenue Ruling 2023-2. My extensive background in tax regulations and case law empowers me to dissect and explain the intricacies of this ruling.
The IRS's recent guidance revolves around Section 1014 of the Internal Revenue Code, which addresses the basis adjustment for property acquired from a decedent. Specifically, the ruling denies a basis adjustment under Section 1014 for property held in a grantor trust upon the death of the grantor. Grantor trusts, as legally distinct entities, play a crucial role in estate planning, and their treatment under tax law is pivotal.
The ruling distinguishes between two types of grantor trusts for estate tax purposes:
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Traditional Grantor Trusts: These trusts are included in the grantor's estate for estate tax purposes. In such trusts, the grantor typically retains significant control over the trust assets, often by maintaining the right to revoke the trust. This lack of a completed gift for gift tax purposes is a key characteristic.
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Intentionally Defective Grantor Trusts (IDGTs): Unlike traditional grantor trusts, IDGTs are not included in the grantor's estate for estate tax purposes. These trusts allow for gifting or selling assets to the trust. However, an administrative power retained by the grantor, such as the ability to substitute trust property, prevents the trust from being considered a separate entity for income tax purposes.
The ruling addressed a specific scenario involving an irrevocable trust where the grantor made a completed gift for gift tax purposes, resulting in the trust being treated as an IDGT. Importantly, the trust assets were not included in the grantor's estate, but the grantor retained a power, leading to income taxation at the grantor's level.
The core issue in this ruling arises when the grantor, after the trust assets appreciated, passes away. The question is whether the assets in the trust would receive a basis step-up on the grantor's death, even though the trust assets were not part of the grantor's gross estate.
The ruling meticulously reviews applicable statutes and case law, ultimately concluding that the trust assets do not qualify for a basis adjustment under Section 1014. This determination is based on the premise that the property in the trust is not considered to have been acquired or passed from a decedent under Section 1014(a).
Importantly, the ruling is limited in its scope to situations where the liabilities of the trust do not exceed the basis of the assets at the date of the decedent's death, and neither the trust nor the grantor holds a note on which the other is an obligor.
While not explicitly stated in the ruling, it suggests that, in the absence of the fair market value adjustment provided for in Section 1014, the general rule of Section 1015 would apply. Section 1015 generally provides for a carryover basis for direct gifts from a grantor and for transfers in trust.
In summary, this IRS guidance underscores the nuanced treatment of grantor trusts, particularly IDGTs, in the context of basis adjustments upon the death of the grantor. It emphasizes the importance of understanding the specific circ*mstances and terms of the trust to navigate the complex interplay between estate and income tax implications.
