Don’t Wait for Us
On March 20, 2023, Senators Warren, Sanders, Van Hollen, and Whitehouse addressed a letter to Treasury Secretary Yellen in which they urged Yellen “to use [her] existing authority to limit the ultra-wealthy’s abuse of trusts to avoid paying taxes.”[i]
According to the Senators, “[b]illionaires and multi-millionaires use trusts to shift wealth to their heirs tax-free, dodging federal estate and gift taxes.”[ii] The letter goes on to explain that,
“Tax avoidance through grantor trusts starts with the ultra-wealthy putting assets into a trust with the intention of transferring them to heirs.  . . . the structures of some of these grantor trusts allow the transfer of massive sums tax-free. Tax planning via grantor trusts . . . is a kind of shell game, with a wealthy person . . . able to pass assets back and forth in ways that effectively pass wealth to heirs while minimizing tax liability.”
While reassuring the Administration of their shared “desire to stop tax abuse through use [sic] of grantor trusts,” and confirming their continued support for a legislative solution to the avoidance of federal transfer taxes by the wealthy, the Senators added that they “strongly encourage the Treasury Department” – i.e., the IRS[iii] – to use its existing authority to limit this tax dodging by the ultra-wealthy.”
Among the actions[iv] that the Senators urged the Treasury Department to take with respect to so-called intentionally defective grantor trusts (“IDGT”) is the following:
“The Treasury Department should use its regulatory authority to issue a regulation or revenue ruling confirming the consensus view that IDGT assets that are not part of an estate for estate tax purposes do not receive stepped-up basis when the grantor dies. The IRS has already taken this logical position in informal guidance (Chief Counsel Advice 200937028), but some aggressive practitioners continue to advise clients that trustees or beneficiaries can claim stepped-up basis for assets in an IDGT when the grantor dies, thus eliminating capital gains tax liability. Treasury should stop this aggressive tax avoidance technique by clarifying that assets in an IDGT do not receive stepped-up basis when the grantor dies.”[v]
Nine days later, the IRS released Revenue Ruling 2023-2 (the “Ruling”), in which the Service concluded that the tax basis of those assets of an irrevocable grantor trust, that are not included in a deceased grantor’s gross estate for federal estate tax purposes, should not be adjusted to the fair market value of such assets[vi] as of the grantor’s date of death.[vii]
Did Senators Liz and Bernie strike such fear into Secretary Janet that she immediately cracked the whip over her minions at the IRS, resulting in the seemingly overnight publication of the Ruling? Hardly. Coincidence?
To better appreciate the import, not to mention the timing, of the Ruling’s release, it may be helpful (i) to provide some context, (ii) to describe the “abuse” to which the Senators’ letter refers, and (iii) to consider the more recent legislative proposals, and failures, that catalyzed the preparation and issuance of the Ruling.
Setting the Stage
In general, the goal of estate planning, at least from a tax perspective, is to reduce the amount of estate tax payable upon the death of a taxpayer.[viii] There are a number of ways by which this outcome may be attained. At a basic level, the taxpayer will try to reduce the value of their taxable estate. The most common means by which a taxpayer may achieve this result is by gifting or selling assets to others while the taxpayer is still alive.
A taxpayer’s (“Taxpayer”) completed gift of property to a family member is an effective planning tool because it removes not only the subject property (“Asset”) from Taxpayer’s future estate but also any appreciation realized by the property prior to Taxpayer’s death. Ideally, the gift itself will not subject Taxpayer to federal gift tax, and Taxpayer will not have retained[ix] an interest in or power over the gifted property that would result in the inclusion of such property in Taxpayer’s gross estate for purposes of the estate tax.
A sale of property will freeze the value of an asset in a taxpayer’s estate while shifting the future appreciation to the buyer.[x] For example, assume Asset is worth $X; Taxpayer sells Asset to a family member for a term note in the face amount of $X; the note bears interest at the AFR,[xi] which is payable currently; the principal is payable at maturity. Based on the foregoing, Taxpayer and the buyer have engaged in a value-for-value exchange – there is no gift transfer and, so, Taxpayer preserves their exemption amount. Let’s say that, by the time the note matures, the value of Asset has doubled (to $2X). The buyer satisfies the note by transferring one half of Asset (a value of $X) to Taxpayer. When Taxpayer subsequently dies, the value of their gross estate will not include the $X of appreciation in the value of Asset that occurred during the term of the note. Thus, an amount equal to this $X of appreciation will have been transferred by Taxpayer to the buyer without incurring federal transfer tax.
Unfortunately for Taxpayer, the sale of Asset to the buyer is subject to income tax to the extent of the gain inherent in the property at the time of the sale. Notwithstanding that the resulting income tax liability will not be owed until principal payments are made on the note,[xii] such liability will reduce the economic benefit sought to be achieved by the transfer.[xiii]
Enter the transfer of property by a taxpayer to an irrevocable grantor trust for the benefit of their family.
The Code provides that the taxpayer-grantor of a trust[xiv] will be treated as the owner for income tax purposes of any portion of the trust (a “grantor trust”) with respect to which the taxpayer has retained certain rights or powers.[xv] In that case, the taxable income of the taxpayer-grantor (as the deemed owner of the trust) will include those items of income, deduction, and credit of the trust that are attributable to that portion of the trust.
In other words, if the taxpayer-grantor is treated as the owner of the trust’s property for income tax purposes, can there even been a transfer of property between the taxpayer and the trust, the gain from which must be recognized for such tax purposes?
The answer is no, at least under current income tax law, and the IRS has stated as much.
According to the IRS,[xvi] Taxpayer’s sale of Asset to a trust of which Taxpayer is deemed to be the owner for income tax purposes (“Trust”) should be disregarded for such purposes – one cannot sell property to, or otherwise transact with, oneself. By the same token, no taxable event should occur when Trust transfers property to Taxpayer in exchange for Asset.[xvii]
However, the transfer between Taxpayer and Trust is recognized for purposes of the gift and estate taxes.[xviii] Thus, by selling Asset to Trust for full and adequate consideration,[xix] Taxpayer may remove the post-sale appreciation in the value of Asset from Taxpayer’s future gross estate without incurring a liability for gift tax because there has been a value-for-value exchange with Trust, and without incurring a liability for income tax because there has been no exchange according to the grantor trust rules.[xx]
So long as Taxpayer retains those rights or powers with respect to Trust that caused Trust to be treated as a grantor trust for purposes of the income tax, Taxpayer will continue to be treated as owning Asset, and any transaction between Taxpayer and Trust will be disregarded for purposes of the income tax.[xxi]
For example, if Taxpayer sold Asset to Trust in exchange for a promissory note (“Note”) with a value equal to the fair market value of Asset while Trust was treated as a grantor trust, the exchange would be disregarded for purposes of the income tax.
If Trust satisfies Note while it is still a grantor trust, Taxpayer’s receipt of the principal (plus interest) will be a non-event for purposes of the income tax because there will have been no transfer or payment – Taxpayer cannot make a transfer or payment to themselves.
If the foregoing strategy is successful, the value represented by the property that was sold to the trust will have been frozen in the taxpayer-grantor’s hands at the face amount of the note for purposes of the estate tax.
Thus, if the note is satisfied while the taxpayer-grantor is still alive the taxpayer will receive property with a value equal to the date-of-transfer value of the property transferred to the trust. The remaining trust corpus – i.e., the hopefully appreciated value of the property – passes to the beneficiaries of the trust free of federal transfer tax.[xxii]
Termination of Grantor Trust Status
But what if Taxpayer ceased to be treated as the owner of Trust and of Asset while Note remained outstanding? For example, what if Taxpayer released those retained rights with respect to Trust that caused it to be treated as a grantor trust?
If the taxpayer-owner of a grantor trust were to release their rights with respect to the trust, the trust would cease to be treated as a grantor trust, would be recognized as a separate taxpayer, and any previously disregarded “transfer or exchange” of property made by the taxpayer-grantor to or with the trust would no longer be disregarded for purposes of the income tax.
Where the previously disregarded transfer was structured as a sale of property by the taxpayer-grantor to the trust in exchange for a note from the trust (for purposes of the gift tax), and the trust ceases to be a grantor trust while the note remains outstanding – for example, because the taxpayer-grantor has released their rights with respect to the trust – the property will be treated as having been sold by the taxpayer-grantor to the trust in exchange for the note.
In the case of Taxpayer, if Asset has appreciated in value since the time of the transfer,[xxiii] then the sale should be treated as a bargain sale for income tax purposes. Taxpayer would be treated as having transferred that portion of Asset with a fair market value equal to the unpaid balance of Note; Trust would take that portion of Asset with a cost basis equal to the amount of such balance;[xxiv] Trust would take the excess portion of Asset, which should be treated as having been gifted by Taxpayer for purposes of the income tax, with a carryover basis.[xxv] Taxpayer would recognize gain from the partial sale of Asset as principal payments are made on Note.[xxvi]
What if Trust ceased to be a grantor trust because Taxpayer died and such death necessarily resulted in the release of Taxpayer’s retained rights with respect to Trust?
In that case, the transfer from Taxpayer to Trust would be completed immediately following Taxpayer’s death. Assume that Taxpayer’s estate would be treated as having sold Asset to Trust in exchange for Note. How else would Note have found its way into the hands of Taxpayer’s estate?[xxvii] How would the amount of gain from the sale be determined? In particular, what is the adjusted basis of Asset at the time it is deemed to have been transferred from Taxpayer’s estate to Trust? There’s the rub.[xxviii]
In general, the basis of a property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent is the fair market value of the property at the date of the decedent’s death.
Under the circumstances described above, Taxpayer owned Asset until the moment of their death. Immediately after such death, Trust acquired Asset in exchange for Note.
For purposes of determining the gain from the sale of Asset to Trust, is it appropriate for Taxpayer’s estate to adjust its tax basis for Asset to the property’s fair market value as of Taxpayer’s date of death?
The answer to this question is one on which many taxpayers and the IRS have disagreed, and that the Administration and Congress recently tried to legislate but without success.
“Build Back Better”
Following the President’s introduction of his Build Back Better legislative proposal in April of 2021, the Treasury released the Green Book for the Fiscal Year 2022 Budget, which suggested that transfers of property into an irrevocable grantor trust, and distributions in kind from such a trust, should be treated as gain recognition events for purposes of the income tax.[xxix]
The House Ways and Means version of Mr. Biden’s plan likewise sought to limit the benefits claimed by taxpayer-grantors (and their estates) who sold property to grantor trusts.
Specifically, under the Committee’s proposal, upon the death of the taxpayer-grantor their gross estate would have included the trust assets the grantor was treated as owning under the grantor trust rules immediately before their death. Thus, if the grantor held on the date of their death the right to acquire an asset from the trust in exchange for cash or other property of equivalent value, the trust would have been included in the grantor’s gross estate.
In addition, any distribution from such portion of the trust to one or more beneficiaries during the life of the taxpayer-grantor would have been treated as a gift transfer for purposes of the gift tax.
In determining whether the transfer of property between an irrevocable grantor trust and the taxpayer-grantor constituted a sale for purposes of the income tax, the grantor’s status as the deemed owner would have been disregarded. The taxpayer would have been treated as having sold the property for income tax purposes and would have had to recognize the gain realized.
Priority Guidance Plan
Following the Build Back Better fiasco[xxxi] – and well before the letter from Senators Warren, Sanders, et al, described above – the IRS picked up on the “if you can’t legislate, then regulate” maxim, as is reflected in its most recent Priority Guidance Plan.[xxxii]
As many of you know, the Plan identifies and prioritizes those tax issues that the IRS has determined are most important to taxpayers and tax administration and that should be addressed through regulations, revenue rulings, and other published administrative guidance.
Among the projects identified in the Plan was the following: “Guidance regarding availability of . . . a basis adjustment at the death of the owner of a grantor trust . . . when the trust assets are not included in the owner’s gross estate for estate tax purposes.” Sounds familiar?
That said, the Plan did not indicate whether it was inclined toward the Administration’s approach of treating any transfer to a grantor trust as a gain recognition event for purposes of the income tax or the House’s approach to treat the assets of the trust as part of the taxpayer-grantor’s gross estate for purposes of the estate tax.[xxxiii]
The Breath Before the Plunge[xxxiv]
Before discussing the just-released Revenue Ruling and the IRS’s position regarding the effect of the taxpayer-grantor’s demise upon a grantor trust and the earlier “sale” of the property, it may be helpful to elaborate upon the situations to which the Ruling may be applicable.
Transfer to the Trust
Until the death of the taxpayer-grantor, the taxpayer still owns the trust property for purposes of the income tax and the note in the hands of the taxpayer does not exist for purposes of the income tax. The taxpayer’s death is the event that ends their ownership and from which springs the transfer of the property in exchange for the trust’s note.
Upon the death of taxpayer-grantor, it is clear that their retained rights and powers that caused the trust to be a grantor trust are “released,” the trust ceases to be a grantor trust, the taxpayer’s transfer to the trust – which “began” while they were alive – is completed at that time, at least for purposes of the income tax, and the trust issues a note, not to the taxpayer (who is dead) but to their estate.
Stated differently, until the taxpayer-grantor dies, there has not been a transfer of property – it was still owned by the taxpayer for purposes of the income tax. Because the taxpayer is dead, they cannot be the transferor. Immediately following the taxpayer’s death, their estate holds the note from the trust and, presumably, will continue to receive payments from the trust.
In light of the foregoing, did the taxpayer’s estate receive the property upon their death, then sell the property to the trust for the note?
The value of the note as of the taxpayer’s date of death, plus any accrued but unpaid interest thereon, will be included in the taxpayer’s gross estate for estate tax purposes,[xxxv] notwithstanding they didn’t exist for income tax purposes until after the taxpayer’s death.[xxxvi]
Some have pointed to the foregoing as support for the position that the property that is deemed to have been sold following the death of the taxpayer-grantor should receive a step-up in basis to its then fair market value.
What if the property has appreciated in value between the time that the transfer was completed for purposes of the gift tax and the time of the taxpayer-grantor’s death? In that case, the value of the property transferred would exceed the original face amount of the note.
Does that mean there will be a bargain sale for income tax purposes following the death of the taxpayer? How should the bargain element – the date of death value over the amount of the note – be treated for tax purposes?
In general, the basis of property in the hands of a person acquiring the property from a decedent, or to whom the property passed from a decedent, is the fair market value of the property on the date of the decedent’s death.[xxxvii]
Upon the immediately subsequent sale of the property to the trust, this step-up would offset the consideration received (i.e., the note) and eliminate any gain.[xxxviii]
The IRS, on the other hand, has stated[xxxix] that because the property was transferred to a trust prior to the death of the taxpayer-grantor for purses of the federal transfer taxes, the basis step-up rule should not apply unless the property was included in the taxpayer’s gross estate for purposes of the estate tax.
According to the IRS, because the property held by the trust is not included in the taxpayer-decedent’s gross estate, it should not receive a basis step-up. Thus, the gain realized on the sale that is deemed to occur immediately after the taxpayer-grantor’s death will have to be recognized – whether by the taxpayer’s estate or its beneficiaries – as payments are made on the note.
The IRS’s position is consistent with those situations described in the basis step-up rules of the Code in which property that is considered as having been acquired from the taxpayer-decedent was also included in the decedent’s gross estate. This includes property acquired from the decedent by reason of death, form of ownership, or other conditions, if by reason thereof the property was required to be included in determining the value of the decedent’s gross estate for purposes of the estate tax.[xl]
It is also consistent with the failed legislative proposals described earlier that sought to “remedy” the inconsistency between (i) those income tax rules that cause a trust to be treated as a grantor trust and (ii) the estate and gift tax rules that do not require the inclusion of such a trust in the taxpayer-grantor’s gross estate.
Which brings us to the recent Ruling.
The Ruling considered whether the Code provides for a basis adjustment to fair market value for the assets of a trust upon the death of the individual taxpayer who was treated as the owner of the trust for purposes of the income tax (a grantor trust) if the trust is not includible in such taxpayer’s gross estate for purposes of the estate tax?
The circumstances in which the Ruling considers this question are straightforward. Before their death, the deceased taxpayer was treated as the owner of the trust for income tax purposes. At the time of the taxpayer’s death, the trust was not the obligor on a note that had been exchanged by the trust as consideration for the acquisition of property from the taxpayer prior to their death.[xli]
In other words, the Ruling is concerned with a trust to which the taxpayer (i) never sold property (all the transfers to the trust were gratuitous for purposes of the gift tax), or (ii) sold property in exchange for a note that was satisfied by the trust prior to the taxpayer’s demise.
In addition, the taxpayer did not retain any rights with respect to the trust or the transferred property that would result in the inclusion of the trust’s property in the taxpayer’s gross estate for purposes of the estate tax.
The Code and Regs
The Ruling begins by reviewing the basis adjustment rules that are applied to property that is transferred (or deemed transferred) by a taxpayer upon their demise.
In general, the Code provides that the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent is the fair market value of the property at the date of the decedent’s death.[xlii]
The Code describes the situations in which a property acquired by a taxpayer is considered to have been acquired from, or to have passed from, the decedent for purposes the above-referenced basis adjustment rules.[xliii] With respect to the circumstances set forth in the Ruling, the following two situations are relevant:
• The property was acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent[xliv]; and
• The property was acquired from the decedent by reason of death, form of ownership, or other conditions (including property acquired through the exercise or non-exercise of a power of appointment), if by reason thereof the property was included in determining the value of the decedent’s gross estate.[xlv]
The IRS has, by regulation, prescribed that property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent, whether the property was acquired under the decedent’s will or under the law governing the descent and distribution of the property of decedents, is considered to have been acquired from a decedent for purposes of the basis adjustment rule.[xlvi]
The IRS has similarly prescribed that property is generally considered to have been acquired from a decedent to the extent that both of the following conditions are met: (i) the property was acquired from the decedent by reason of death, form of ownership, or other conditions, and (ii) the property is includible in the decedent’s gross estate because of such acquisition.[xlvii]
The Ruling’s Analysis
According to the Ruling, for property to receive a basis adjustment upon the death of a taxpayer, the property must have been acquired or passed from a decedent. For property to have been acquired or to have passed from a decedent for purposes of the basis adjustment rule, it must fall within one of the two situations described above.
The IRS determined that Asset did not satisfy this requirement.
The Ruling explained that, upon Taxpayer’s death, Asset was not “bequeathed,” “devised,” or “inherited” by Trust. The Ruling stated that a “bequest” is the act of giving property by will; a “devise,” it continued, is the act of giving real property by will. An “inheritance” is property received from one’s ancestor under the laws of intestacy.
According to the IRS, Asset was transferred to Trust prior to Taxpayer’s death;[xlviii] it was not bequeathed or inherited because it did not pass either by will or intestacy, at least according to the usual meaning of such terms.
The Ruling also noted, without much discussion, that Taxpayer’s death did not transfer Asset to Trust, yet that is exactly what happened from the perspective of the grantor trust rules and the income tax.
Most significantly, the IRS added that property could not be said to have come from a decedent unless it was part of the decedent’s estate.
Thus, the Ruling held that Asset was not acquired from decedent Taxpayer by reason of their death, form of ownership or other condition because Asset was not included in Taxpayer’s gross estate for purposes of the estate tax.
Based on the foregoing, the IRS determined that Asset should not receive a basis adjustment to fair market value upon Taxpayer’s demise.
Instead, the basis of Asset immediately after Taxpayer’s death should be the same as it was immediately prior to such death.
What Does It Mean?
A revenue ruling is an official interpretation by the IRS of the Code and related regulations. It represents the IRS’s conclusion on how the tax law is applied to a specific set of facts.[xlix]
The conclusion set forth in the Ruling is based upon the following not atypical fact pattern:
- Taxpayer established Trust
- Taxpayer transferred Asset to Trust by way of a completed gift for purposes of the gift tax
- There was no sale by Taxpayer to Trust in exchange for a note
- Taxpayer retained certain rights with respect to Trust
- The retained rights caused Taxpayer to be treated as the owner of Asset for purposes of the income tax under the grantor trust rules
- The retained rights would not cause Asset to be included in Taxpayer’s gross estate for purposes of the estate tax
- Taxpayer died
- Trust ceased to be a grantor trust
- At the time of Taxpayer’s death, neither Trust nor Taxpayer was indebted to the other.
In short, the Ruling holds that there will be no adjustment to the basis of the assets of a grantor trust upon the death of the grantor when such assets are not included in the grantor’s gross estate for purposes of the estate tax.
No taxpayer-grantor should be surprised by this outcome.
When an individual taxpayer creates a trust and gifts property to the trust, they do so with the goal of removing such property and the future appreciation in its value from the taxpayer’s gross estate, and they do so with the understanding that the trust will take the property with the same basis the property had in the hands of the taxpayer.
Moreover, the taxpayer was advised that qualifying the trust as a grantor trust would not expose them to estate tax but would afford them the opportunity to make a tax-free gift every year by reporting the trust’s income on the taxpayer’s own income tax return.[l]
At no point was the taxpayer told that, upon their death, the basis of the trust property would be adjusted to its then fair market value notwithstanding that, for purposes of the income tax, the trust property was not “transferred” to the trust until the taxpayer’s demise.
Thus, the Ruling’s holding covers the vast majority of gift transfers to a trust that is treated as a grantor trust.
Should there be a different result if, when the trust ceases to be a grantor trust, the trust is obligated to the grantor on a purchase money note that was exchanged by the trust for the property “transferred” to the trust for purposes of the gift tax?
As described earlier, the sale of property by the grantor to the trust is completed for purposes of the income tax at the death of the grantor. At that point, the grantor’s estate should be treated as having sold the property to the trust in exchange for a note with a face amount equal to the fair market value of the property as of the date the transfer was completed for purposes of the gift tax. If the value of the property has appreciated since that time, the excess value constitutes an inheritance (or gift) for purposes of the income tax.[li]
But does the fact of a sale affect the transferor’s basis for the property sold? It shouldn’t, at least not under the reasoning of the Ruling.
Why, then, did the Ruling expressly state that there were no obligations owing between Taxpayer and Trust, and that Trust did not have liabilities in excess of Asset’s basis?[lii] Is the IRS still considering this particular situation? Time will tell.
In the meanwhile, taxpayers and their advisers will have to consider the Ruling when preparing for the transfer of property to a grantor trust in exchange for a note or other consideration. They should also remain alert for other pronouncements pursuant to the Priority Guidance Plan.
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[i] Not once does the letter refer to tax “evasion.” Instead, it mentions “avoiding” taxes and “dodging” taxes.
To quote the IRS: “Tax evasion is illegal. . . . In contrast, tax avoidance is perfectly legal.”
The use of “dodging” represents an interesting choice of words by the Senators – it blurs the line but connotes an illegal activity.
[iii] The IRS is the largest bureau of the Treasury Department.
[iv] Other actions items include: (a) revoking Rev. Rul. 85-13 thereby treating sales between a grantor and a grantor trust as taxable events, (b) revoking Rev. Rul. 2004-64, thus turning the grantor’s payment of the income tax attributable to a grantor trust into a gift, (c) requiring that GRATs have a minimum remainder value of 25% of the contributed assets, eliminating zeroed-out GRATs, and (d) reissuing proposed regulations to greatly restrict the application of valuation discounts in connection with the transfer of interests in family partnerships.
[v] The full text of above-referenced CCA is as follows:
We strongly disagree with taxpayer’s contention. In this case, the taxpayer transferred assets into a trust and reserved the power to substitute assets. Section 1014(b)(1)-(10) describes the circumstances under which property is treated as having been acquired from the decedent for purposes of the section 1014 step-up basis rule. Since the decedent transferred the property into trust, section 1014(b)(1) does not apply. Sections 1014(b)(2) and (b)(3) apply to transfers in trust, but do not apply here, because the decedent did not reserve the right to revoke or amend the trust. None of the other provisions appear to apply at all in this case. Quoting from section 1.1014-1(a) of the Regulations: “The purpose of section 1014 is, in general, to provide a basis for property acquired from a decedent which is equal to the value placed upon such property for purposes of the Federal estate tax. Accordingly, the general rule is that the basis of property acquired from a decedent is the fair market value of such property at the date of the decedent’s death. . . . Property acquired from the decedent includes, principally, . . . property required to be included in determining the value of the decedent’s gross estate under any provision of the [Internal Revenue Code.]” Based on my reading of the statute and the regulations, it would seem that the general rule is that property transferred prior to death, even to a grantor trust, would not be subject to section 1014, unless the property is included in the gross estate for federal estate tax purposes as per section 1014(b)(9).
[vi] In general, IRC Sec. 1014 requires that the basis for an asset in the hands of a taxpayer who acquires the asset from a decedent be adjusted to the fair market value of such asset as of the date of the decedent’s death – in other words, the basis is marked to market. Of course, there is no guarantee that the value of an asset will not have dropped below the decedent’s basis in the asset by the time of their death, thus eliminating the benefit of a built-in loss in the hands of the transferee.
[viii] No, I haven’t forgotten about the GST tax.
[ix] Whether explicitly or under an implied agreement with the donee.
[x] A sale will often make sense where the taxpayer has almost exhausted their exemption amount.
[xi] The applicable federal rate under IRC Sec. 1274.
[xii] Assume the sale of Asset qualifies for installment reporting in its entirety under IRC Sec. 453.
[xiii] In the end, it’s all about economics.
[xiv] Basically, the individual who created and transferred property to the trust.
[xv] IRC Sec. 671 et seq.
For example, the right to acquire trust property in exchange for other property of substantially equivalent value. IRC Sec. 675(4).
[xvi] Rev. Rul. 85-13. This is one of the rulings the Senators would like the IRS to revoke.
[xvii] The grantor trust rules were originally enacted to prevent parents who were subject to a higher rate of tax from shifting income to the beneficiaries of a trust who were subject to a lower rate of tax, while at the same time retaining a measure of control over the trust.
[xviii] The grantor trust rules are limited to the income tax.
[xix] IRC Sec. 2043.
[xx] The sale of property to a grantor trust takes advantage of the inconsistency between the income tax and transfer tax rules – specifically, the ability to sell a property for gift tax purposes, but to still own it for income tax purposes – in order to transfer wealth while minimizing the gift and income tax cost of such transfers.
[xxi] If the foregoing outcome wasn’t bad enough for the IRS, capital gains taxes from the future disposition of the trust’s property may also be avoided by the taxpayer’s “repurchase,” at fair market value, of the appreciated asset from the grantor trust and the subsequent inclusion of that asset in taxpayer’s gross estate at death. Under current law, the basis in the reacquired asset would then be adjusted (generally, “stepped-up”) to its fair market value at the time of the grantor’s death, often at an estate tax cost that has been reduced by the grantor’s utilization of their exemption amount.
[xxii] Assume the sale to the trust was preceded by a gift to which the taxpayer allocated some of their GSTT exemption.
[xxiii] The taxpayer would have been hoping for such appreciation when they undertook the transaction. It’s the appreciation that escapes the transfer tax. GRATs operate under the same principle.
[xxiv] IRC Sec. 1012. Assume the note bears adequate interest. IRC Sec. 1274,
[xxv] IRC Sec. 1015.
[xxvi] See IRC Sec. 453. Beware Sec, 453A.
[xxvii] Is there an argument that Taxpayer’s estate should be treated as the seller?
For example, for two years following the death a taxpayer-grantor, the former grantor trust is treated as the owner of the S corporation shares held by the trust for purposes of IRC Sec. 1366. Reg. Sec. 1.1361-1(h)(3)(ii)(A).
[xxviii] From Hamlet’s famous soliloquy.
[xxix] The deemed owner of a revocable grantor trust would have recognized gain on the unrealized appreciation in any asset distributed from the trust to any person other than the deemed owner or the U.S. spouse of the deemed owner. All the unrealized appreciation on assets of a revocable grantor trust would have been realized at the deemed owner’s death or at any other time when the trust became irrevocable.
[xxx] In late October 2021, the House Rules Committee introduced a much-revised version of the bill, which no longer sought to limit the use of grantor trusts. Still, as 2021 slipped into 2022, the Dems were unable to pass the bill.
Having squandered their opportunity, and following their loss of the House at the end of 2022, the Administration’s 2023-2024 Budget nevertheless proposes that the transfer of an asset between an irrevocable grantor trust and its deemed owner should not be disregarded for income tax purposes and should result in the grantor recognizing gain on any appreciation in the transferred asset. Such regarded transfers would include sales as well as the satisfaction of a trust obligation with appreciated property. Thus, transfers of property into, and distributions in kind from an irrevocable grantor trust that is deemed to be wholly owned and revocable by the donor, would be recognition events.
[xxxi] “Kudos” to Senators Manchin and Sinema? The former is practically a shade now (in the Classical sense) and the latter is an Independent who caucuses with the Democrats (just like Bernie, who calls himself a Social Democrat.) They should have spoken up a lot sooner than they did. The contents of the Administration’s plan were not a secret. So much wasted time and effort. A circus atmosphere. Not the way to legislate.
[xxxiii] As an aside: whatever approach is ultimately chosen, one must not lose sight of the potential impact under state tax laws.
[xxxiv] Apologies to Gandalf.
[xxxv] Obviously, we’re assuming the note is not a SCIN (self-cancelling installment note).
[xxxvi] Under the circumstances, can the note ever represent an item of “income in respect of a decedent”? IRC Sec. 691.
[xxxvii] IRC Sec. 1014(a).
[xxxviii] IRC Sec. 1001.
[xxxix] One example of the IRS’s position is the CCA cited in the Senators’ letter.
[xl] IRC Sec. 1014(b)(9).
[xli] In addition, the liabilities of the trust did not exceed the basis of the trust’s assets. Thus, there was no gain from the deemed sale of assets by the grantor to the trust for which the debt assumed or taken subject to by the trust represented consideration.
[xlii] IRC Sec. 1014(a). The purpose of Sec. 1014 is, in general, to provide a basis for property acquired from a decedent that is equal to the value of such property for purposes of the estate tax. Accordingly, the general rule is that the basis of property acquired from a decedent is the fair market value of such property on the date of the decedent’s death. Reg. Sec. 1.1014-1(a).
[xliii] IRC Sec. 1014(b).
[xliv] IRC Sec. 1014(b)(1).
[xlv] IRC Sec. 1014(b)(9). Note that IRC Sec. 1014(b)(9) does not apply to property described in any other paragraph of IRC Sec. 1014(b). IRC Sec. 1014(b)(9)(C).
[xlvi] IRC Sec. 1.1014-2(a)(1). The basis of such property is adjusted to fair market value.
[xlvii] Reg. Sec. 1.1014-2(b)(1). The basis of such property in the hands of the person who acquired it from the decedent is adjusted to fair market value.
It is not necessary for the application of this rule that an estate tax return be required to be filed for the estate of the decedent or that an estate tax be payable. Reg. Sec. 1.1014-2(b)(2).
[xlviii] Although not expressly stated, the Ruling is applying a non-income tax interpretation of “transfer.” Under the grantor trust rules, the transfer occurred immediately following Taxpayer’s death.
[xlix] That said, it does not have the same effect as a regulation, nor is it treated as binding precedent, though most courts will show a not insignificant degree of deference toward a revenue ruling.
[l] Rev. Rul. 2004-64.
[li] IRC Sec. 102.
[lii] The deemed transfer of encumbered property is treated in part as a sale. See, e.g., Reg. Sec. 1.1001-2. That said, neither the courts nor the IRS has ever treated the transfer of such property at death as a sale.