For years, we have used lifetime gifts to irrevocable trusts for clients with large estates. Assets gifted to an irrevocable trust removes the gifted assets from a client’s taxable estate at their death reducing their estate tax burden. A portion of the taxpayer’s lifetime estate and gift tax exemption would typically be used by making the gift; however, any appreciation in the assets after the date of the gift would also be out of the Trustmaker’s estate and therefore not be subject to estate tax upon the death of the Trustmaker. We often use this technique for appreciating assets. We refer to these appreciating gifts to trusts as a “freezing” technique.
In the last 20 years or so, structuring the irrevocable trust as a “grantor trust”, what we refer to as an intentionally defective grantor trust (IDGT) allowed the Trustmaker to get the asset(s) out of the Trustmaker’s estate but continue to be responsible for the income taxes generated by the trust during their lifetime. This provides an opportunity for the Trustmaker to continue to make “gifts” to the beneficiary of the trust by paying the income tax liabilities of the trust without using additional gift tax exemption. This tool can be turned on and off by the Trustmaker annually and has not been affected by the Revenue Ruling.
However, an additional “income tax” benefit was that the assets of the IDGT also received a “step-up” in basis at the death of the Trustmaker. In March the IRS issued Revenue Ruling 2023-02 relating to the basis step-up at the passing of the Trustmaker. The Revenue Ruling states that completed gifts to an IDGT will not receive a step-up in basis at the death of the Trustmaker under IRC §1014. Because the assets are not included in the taxable estate of the Trustmaker, the IRS is taking the position that this is not an asset of the Trustmaker’s that should receive a step-up in basis at death. Although logical, this was a powerful tool we have used successfully for many years.
Fortunately most of the irrevocable trusts prepared by the attorneys at Thrash, Carroll & Vanway Law Group include “swapping powers,” allowing the Trustmaker to swap low basis trust assets for higher basis assets of equal value during his or her lifetime. There are additional protections typically built into our trusts, and for clients who may not be estate taxable at their death other possible work arounds.
NOTE: this ruling does not affect regular revocable estate planning trusts, and should not worry clients who created trusts for special needs beneficiaries. Life insurance trusts are also not affected. However, many of our clients who have created irrevocable trusts for children and grandchildren or, in some cases, trusts for spouses in anticipation of the “sunset” of the $12,920,000 + estate tax exemption in 2026 may be affected. If you are concerned about the effect of this change on your irrevocable trust prepared by our law firm or by another law firm, contact your attorney at info@tcvlaw.com or make an appointment with one of the Thrash, Carroll & Vanway Law Group attorneys to discuss.