The ruling deals with a long-used basis adjustment in federal estate taxes . Clients get a step-up in tax basis for assets in their gross estates under Section 1014 of the Internal Revenue Code ; that offers them a savings on capital gains for heirs . But the new rule clarifies that these adjustments generally don ’ t apply to the assets sitting in an irrevocable grantor trust that are consid- ered to be outside the deceased grantor ’ s gross estate .

“ Over the years , more aggressive tax practitioners have sought to exclude trust assets from their client ’ s estate while simultaneously adjusting them for basis step-up at death ,” says Liting Chuang , director of tax planning and associate wealth advisor at Bordeaux Wealth Advisors , headquartered in Menlo Park , Calif .

After years of pressure from Congress to close that perceived basis adjustment loophole , Chuang says , Revenue Ruling 2023-2 is the first effort by the IRS to formally clar-

Revenue Ruling 2023-2 is the first effort by the IRS to formally clarify that a basis adjustment can ’ t be used for intentionally defective irrevocable trusts under Section 1014 . ify that the basis adjustment can ’ t be used for intentionally defective irrevocable trusts under Section 1014 .

“ Irrevocable grantor trusts have a dual , and somewhat conflicting , nature : The income earned by the trust is included in the grantor ’ s taxable income , but the assets within the trust are excluded from the grantor ’ s estate for federal estate tax purposes ,” says Sophia Duffy , an associate professor of business planning at the American College of Financial Services in King of Prussia , Pa . The question then , she says , is whether the trust assets get a basis adjustment to fair market value at the decedent ’ s death .

Azriel J . Baer , a partner in the trust and estates group at the law firm Farrell Fritz in Uniondale , N . Y ., believes many practitioners were already taking positions consistent with the ruling .

“ Assume a client gifted property with an income tax basis of $ 1 million to a trust in year one and died in year 10 when the property had a fair market value of $ 10 million ,” Baer says . “ If the trustees then sell the appreciated property for $ 10 million , the trust would need to pay capital gains tax on $ 9 million . This capital gains tax could distort the overall estate plan if the grantor had completed the rest of his planning assuming this trust would receive a basis adjustment at death .”

The main planning benefit of the irrevocable grantor trust is that a gift to the trust is treated as a complete gift for gift tax purposes , which removes future appreciation of the asset from the taxable estate of the grantor while permitting the grantor to continue to pay income taxes on the trust ,” says Jennifer Junker , chief fiduciary officer at Arden Trust Company in Atlanta . “ Payment of income taxes is not treated as a gift .”

Even with the recent ruling , keep in mind : “ Revenue Rulings are not binding on any federal court , including the U . S . Tax Court , as they represent arguments of one party ,”

12 | FINANCIAL ADVISOR MAGAZINE | JUNE 2023 WWW . FA-MAG . COM