This double trust benefit really is too good to be true

VaselineSeptember 15, 2024

0 3 minutes read

This double trust benefit really is too good to be true

Editor’s Note: This is part 11 of an ongoing series on using trusts and LLCs in estate planning, asset protection and tax planning. The effectiveness of these powerful tools—especially for asset protection and tax planning—depends heavily on how they are configured to work together and whether certain types of control over assets and property are relinquished by the property owner. See below for links to the other articles in the series.

Some trust creators and taxpayers have been confused about, or perhaps in denial about, the tradeoffs between asset control and the capital gains tax planning potential of irrevocable trusts.

They hoped that by paying taxes on the income of a completed gift trust under the powers of the grantor trust, the trust would be eligible for both a step-up in basis and the estate tax exclusion. This double benefit was simply too good to be true.

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An irrevocable trust can be treated as a grantor trust, which means that one person (usually the creator of the trust) will be treated as the owner of the income or principal of the trust, and the individual will include all items of trust income, deductions and credits on their personal taxes as if the person had received them personally – even if the trust did not distribute their personal income and the income remains in the trust.

Most people will save on the total taxes due on the taxable income from the trust by paying tax themselves at their individual tax rates, which are usually lower than the trust’s tax rates, making the use of grantor trusts an attractive strategy to tax savings.

An IRS clarification

In early 2023, the IRS issued Revenue Ruling 2023-02, under which the IRS clarified that if assets in an irrevocable trust are excluded from the trust creator’s gross estate, then the assets excluded from the estate will not receive a step-up of the base. for capital gains tax under section 1014 of the Internal Revenue Code, even though the irrevocable settlor continued to pay income taxes on the trust’s income under the grantor trust’s income tax rules. In other words, Revenue Ruling 2023-02 removed the confusion and conflation of very different sets of trust tax rules: the income tax rules, the capital gains tax rules, and the gift and estate tax rules.

While the impact of Revenue Ruling 2023-02 has been exaggerated by some, it was really only a clarification of existing laws rather than a dramatic change. The reality is that Revenue Ruling 2023-02 reiterated what many tax-savvy estate planning attorneys already knew was clear: property that is transferred to an irrevocable trust under a completed gift does not qualify for a step-up in the income tax basis of capital. savings, even if the trust settlor continues to pay the trust’s income taxes.

However, Revenue Ruling 2023-02 came as a shock to some lawyers and trust creators who had hoped to have their cake and eat it too by paying taxes on trust income below the lower individual tax rates, excluding property from gross estate and obtaining a step-up basis to save capital gains taxes.

Step-up-in-base technique

Maintaining a trust as a grantor so that the settlor personally pays the trust taxes at lower rates has never been a valid technique to step up basis in completed gift trust assets that are outside of the trust’s gross estate. The grantor trust income rules treat an individual taxpayer as the owner of the trust income or principal, so that the individual pays income tax on the trust income (usually at lower individual tax rates), rather than the trust paying taxes on the income of the trust (usually at the larger trust). tax rates).

On the other hand, a completed gift of property from the trust creator’s gross estate has always resulted in the denial of a step-up in the capital gains tax basis at the time of death.

To restate the key issue, it is critical that a trust creator realizes that they cannot both make a completed gift of their taxable estate and qualify for a step-up in basis in the trust assets simply by granting the trust status. issuer of assets to the trust.

Vaseline

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