What the Latest IRS Ruling Means for Trusts

What You Need to Know

Tax experts say a new IRS revenue ruling could have a significant impact on certain wealthy clients.
In the ruling, the IRS considers whether assets in a “defective” trust can receive a step-up in basis upon the original owner's death.
While complex, the estate planning concepts addressed in the ruling can help guide clients as they make legacy plans.

A new revenue ruling issued by the Internal Revenue Service confirms that assets held in an irrevocable trust, when there has been a completed gift, do not receive a step-up in basis upon the death of the original owner.

According to a number of tax and estate planning experts, the newly issued IRS Revenue Ruling 2023-02 is likely to impact only highly wealthy clients, such as those who own a successful business, but the IRS’ ruling is still instructive for those engaging in more advanced estate planning.

Specifically, the ruling addresses a situation in which a person creates an irrevocable trust and retains authority over and ownership of the trust for income tax purposes under the Internal Revenue Code’s Chapter 1, but they do so in such a way that does not cause the trust assets to be included in their gross estate for purposes of Revenue Code Chapter 11.

In such a situation, if the person funds the trust with an asset in a transaction that is a completed gift for gift tax purposes, the basis of the asset is not adjusted to its fair market value on the date of the original owner’s death — as stipulated by Code Section 1014. This is, in short, because the asset was not “acquired or passed from a decedent,” as defined in Section 1014(b).

Accordingly, under the new ruling’s facts, the basis of the asset immediately after the original owner’s death is the same as the basis of the asset immediately prior to their death.

Does the Ruling Make Sense?

Richard Austin, executive director at Integrated Partners, tells ThinkAdvisor that the conclusion in the complex ruling “makes sense and is the correct result.”

“Revenue Ruling 2023-02 confirms that assets held in an irrevocable trust, when there has been a completed gift, do not receive a step-up in basis,” Austin explains. “This makes sense, since the transfer in question occurred when there was a completed gift with a transferred basis before the death of the grantor.”

As Austin spells out, trusts constructed in this way are often referred to as being “defective” for income tax purposes.

“A grantor trust that is defective for income tax purposes, but not estate tax purposes, has been an item listed in Greenbook, whereby the federal government is looking to decrease the benefits of grantor trusts,” Austin says.

Details of the Ruling

According to the ruling, for property to receive a basis adjustment under Section 1014(a), the property “must be acquired or passed from a decedent.”

For property to be acquired or passed from a decedent for purposes of Section 1014(a), in turn, it must fall within one of the seven types of property listed in Section 1014(b). In this case, the asset under consideration does not fall within any of the seven types of property listed in that section, for several demonstrable reasons.

First, upon the original owner’s death, the asset was not “bequeathed,” “devised,” or “inherited” within the meaning of Section 1014(b)(1). As the IRS spells out, a “bequest” is the act of giving property (usually personal property or money) by will.

Second, the asset does not fall within any of the remaining types of property listed in Section 1014(b), because the original owner did not retain the power to revoke or amend the trust. Additionally, the asset is not described by Section 1014(b)(6) because it is not community property.

Finally, as noted earlier, the asset is not included in the original owner’s gross estate under the provisions of Chapter 11. Thus, because the asset does not fall within any of the seven types of property listed in Section 1014(b), the asset does not receive a basis adjustment under Section 1014(a) at the original owner’s death.