Baker McKensie reports on IRS Revenue Ruling 2023-2, which states that assets in irrevocable grantor trusts won’t have basis adjustments upon grantor’s death without meeting the criteria for being acquired or passed from a decedent.
In brief
In most cases, a US taxpayer’s capital gains upon the sale of an asset will be calculated by subtracting the basis (usually the cost) of the asset from the sales price.
If a US taxpayer receives an asset as a gift, the asset’s basis remains the same as when it was held by the donor.
However, the basis of an asset that is considered to have been acquired from or to have passed from a decedent will actually be adjusted to its fair market value (FMV) on the date of the decedent’s death.
Making a completed gift to an irrevocable trust while retaining limited powers that would cause the trust to be treated as a grantor trust but not cause the trust assets to be includible in the grantor’s estate is a common US estate tax planning technique.
While the trust receives the assets by way of a gift in the above scenario, for income tax purposes, the grantor is considered to own the assets until death. This causes some practitioners and commentators to argue that the assets in an irrevocable grantor trust should also be eligible for a basis adjustment upon the grantor’s death despite otherwise not meeting the requirements to be considered to have been acquired from or to have passed from a decedent.
The US government indicated its intention to issue guidance on this topic in the past and recently did so by issuing Revenue Ruling 2023-2. It held that the assets in an irrevocable grantor trust do not receive a basis adjustment upon the grantor’s death if the assets do not meet the requirements to be considered to have been acquired from or to have passed from a decedent and are not otherwise subject to US federal estate tax.
Introduction
The US Internal Revenue Service (IRS) has weighed in on the long-standing debate on what the basis of assets in an irrevocable grantor trust will be upon the grantor’s death.
The question is an important one. For US federal income tax purposes, capital gains are calculated by subtracting the taxpayer’s basis in the capital asset (e.g., the acquisition cost) from the value received upon the sale or exchange of the asset (e.g., the sale price). If an asset is received by way of a lifetime gift, the donee taxpayer’s basis will be same as that of the donor (i.e., a “carry-over basis”). However, for an asset acquired or passing from a decedent, the recipient taxpayer’s basis will be equal to the FMV of the asset on the date of the decedent’s death. There has been debate among tax practitioners as to the basis of the assets of a trust upon the grantor’s death, where a grantor has made an irrevocable, completed gift to the trust but nevertheless retained sufficient powers so that the grantor is treated as the owner of the trust’s assets and income during their lifetime. In such cases, the trust assets would generally not be subject to US federal estate tax upon the grantor’s death (due to having made a completed gift to the trust during life). However, some practitioners and commentators have argued that the trust assets should qualify for a basis adjustment to FMV upon the grantor’s death.
In 2015, the US Department of the Treasury stated its intention to issue “guidance on basis of grantor trust assets at death under [Section 1014 of the Code].” Those plans took a more definite shape when the Department, in its 2022-2023 Priority Guidance Plan, said it would provide “guidance regarding availability of [that section’s] basis adjustment upon the death of the owner of a grantor trust described in [Section] 671 when the trust assets are not included in the owner’s gross estate for estate tax purposes.”
Now, the IRS has opined on this very question.
Background
Section 1014(a) provides that, for property to receive a basis adjustment to its FMV on the date of the decedent’s death, the property must be acquired or passed from a decedent. The Treasury Regulations provide that property acquired from a decedent includes, principally, (1) property acquired by bequest, devise, or inheritance, or by the decedent’s estate, under the decedent’s will or the law governing the descent and distribution of the decedent’s property, and (2) for decedents who die after 31 December 1953, property required to be included in the decedent’s gross estate.
Section 1014(b) clarifies that property is considered to have been acquired from or to have passed from a decedent if it falls within one of seven types of property, including notably (1) property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent, (2) property transferred in trust to pay income for life to or on the order or direction of the decedent with either the power to revoke the trust or the power to change the enjoyment of the trust reserved at all times to the decedent, and (3) property acquired from the decedent by reason of death, form of ownership, or other conditions thereby requiring the property to be included in determining the value of the decedent’s gross estate for US federal estate tax purposes.
While property transferred by completed gift to an irrevocable grantor trust would not meet any of the circumstances qualifying for a basis adjustment at death, this Section does not squarely address the situation where the grantor continues to be treated as the owner of the trust’s assets for US federal income tax purposes until death.
Given that the grantor of an irrevocable grantor trust is the owner of the trust property for US federal income tax purposes and the grantor ceases to be treated as such at the moment of death, the argument follows that the trust could be treated as acquiring the trust property from the grantor-decedent for income tax purposes at death and should be eligible for a basis adjustment.