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IRS Confirms No Step-Up for Irrevocable Trusts

The IRS recently issued a ruling related to the Section 1014 basis step-up, a profoundly important way in which taxpayers deal with estate planning issues. First, a little background…Section 1014 of the Internal Revenue Code allows a “step-up” in tax basis for any assets acquired from a decedent after their death. This essentially allows the assets to receive a basis increase to the fair market value as of the date of the decedent’s death (or an alternate valuation date) and long-term tax treatment.

An Irrevocable Grantor Trust is a trust in which the grantor transfers assets to a trust, removing those assets from their estate. However, while the grantor is no longer the owner of the assets, the grantor does retain ownership for income tax purposes.  

Most practitioners have taken the position that assets transferred to an Irrevocable Grantor Trust during the life of the grantor do not receive a step-up in basis. However, there has been some debate on this issue and some practitioners have taken the more aggressive position of stepping up the basis on these assets. The argument is that even though the assets were gifted to the grantor trust, they remained owned by the grantor for income tax purposes.

Revenue Ruling 2023-02 has noted that Section 1014(b) provides seven types of property that are considered to have been acquired from or to have been passed from the decedent. The ruling concludes that property that was transferred to an Irrevocable Grantor trust does not fall within any of the seven types of property listed. Therefore, the ruling concluded that the basis of the assets should not receive a basis adjustment as of the grantor’s death.  Practitioners who may have taken the more aggressive position described above on a previously filed return may want to amend such returns in light of this ruling to reduce the possibility of penalties if the step-up in basis is reviewed and denied.

Finally, it should be noted that a Revenue Ruling is an interpretation of the law by the Internal Revenue Service and can be relied on by taxpayers. However, Revenue Rulings do not carry the force and effect of regulations.

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