On March 29, 2023, the IRS resolved one important question involving the commonly used “intentionally defective grantor trusts” (IDGTs) — irrevocable trusts specially designed to accept completed gifts yet be disregarded for income tax purposes. Contrary to arguments made by some tax practitioners, the IRS ruled IDGT assets are not eligible for a “step-up” in basis to fair market value at the trustor’s death.
Internal Revenue Code section 1014 generally provides that the basis of property acquired from a decedent is equal to the fair market value of that property as of the decedent’s date of death (unless the property is otherwise disposed of prior to the decedent’s death).
For example, assume Winston leaves a baseball card in his will to Hudson that he bought for $1,000 (basis) and is worth $10,000 when he dies. In that case, Hudson inherits the baseball card with a $10,000 basis, and the $9,000 built-in gain ($10,000 fair market value minus $1,000 basis) is eliminated.
In Revenue Ruling 2023-2, the IRS concluded this basis step-up afforded by section 1014 does not apply to assets in an IDGT (unless those assets are included in the trustor’s gross estate).
Substituting high tax basis assets for low tax basis assets in an IDGT may improve the tax results. Those who have established IDGTs should consider substituting high basis assets held by the trustor for low basis assets held in the trust. That way the high basis assets, which benefit only slightly from a basis step-up, are held in the trust and the low basis assets, which benefit significantly from a basis step-up, are included in the trustor’s gross estate.
For example, assume Lilly’s IDGT owns FounderCo stock with a basis of $250,000 and a fair market value of $1 million, and Lilly individually owns PubCo stock recently purchased for $900,000 with a fair market value of $1 million. If Lilly swaps the PubCo stock for the FounderCo stock, then when Lilly dies, the FounderCo stock (owned by her individually) will receive a basis step-up from $250,000 to the fair market value as of Lilly’s date of death (let’s assume $1 million). The PubCo stock will not receive a step-up in basis at her death and maintains basis of $900,000.
Gift highly appreciated assets may also improve tax results. Those considering creating an IDGT (or making additional gifts to an IDGT) should select highly appreciated (or highly appreciating) assets to give away, all else being equal.
Please reach out to your Baker Tilly advisor if you have questions regarding how this revenue ruling affects you.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.