Recently published Revenue Ruling 2023-02 provides that there is no basis step-up for assets in an IDGT if the assets are not included in the grantor's gross estate upon his or her death. The revenue ruling addresses a topic that has been in the U.S. Department of the Treasury and the IRS’ Priority Guidance Plan for a while and is consistent with the IRS’ renewed enforcement focus on high-income individuals.
IDGTs
An IDGT typically is used to remove income-producing, highly appreciated assets from a grantor’s estate. An IDGT is unique in that it is treated differently for estate and gift tax purposes than for income tax purposes.
Establishing an IDGT requires the grantor to settle an irrevocable trust in which the grantor retains certain powers that cause the trust to be treated as a grantor trust for income tax purposes. A grantor trust is not treated as an entity separate from the grantor for income tax purposes and, therefore, the trust’s income is taxed to the grantor.
For estate and gift tax purposes, however, the trust is treated as an entity separate from the grantor. Generally, assets transferred to the trust are treated as completed gifts and, therefore, are not included in the grantor’s estate upon death.
Crowe observation
While not included in the grantor’s estate, assets transferred to an IDGT could trigger gift tax.
Revenue Ruling 2023-02
Generally, under IRC Section 1014(a), the basis of property in the hands of a person acquiring it from a decedent or to whom the property passed from the decedent, if the property is not sold, exchanged, or otherwise disposed of by that person before the decedent’s death, is the fair market value of the property as of the date of the decedent’s death. This method of determining basis is referred to as a step-up basis, and IRC Section 1014(b) lists the circumstances under which a step-up basis under IRC Section 1014(a) applies.
In Revenue Ruling 2023-02, the IRS held that the basis step-up under IRC Section 1014 does not apply to assets gifted to an irrevocable grantor trust because the assets are not included in the gross estate of the grantor for federal estate tax purposes. The ruling explains that in such cases the assets of the 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, IRC Section 1014(a) does not apply. The ruling further states that for a basis step-up to apply, the property must be acquired or passed from a decedent.
The ruling signals that the IRS will be challenging a step-up in basis of assets if the assets were acquired from an irrevocable grantor trust and were not included in a decedent’s estate.
Looking ahead
The revenue ruling sets forth the IRS’ audit and litigating position. Taxpayers who have settled an IDGT should contact their tax adviser to evaluate how the revenue ruling affects their current estate planning and determine what options are available for those choosing to make a change in those plans.
