Rev. Rul. 2023-2’s impact on estate plans

Editor: Mark G. Cook, CPA, CGMA

Most taxpayers do not need to worry about estate taxes with today’s extraordinary unified credit, which at the time of this writing is $12,920,000 per person and $25,840,000 for married couples. However, this ample credit is set to sunset on Dec. 31, 2025. Without congressional intervention, Jan. 1, 2026, will see the credit restored to a much lower amount of $5,490,000 plus an adjustment for inflation, which is predicted to land the credit somewhere around $6 million per individual (double for a married couple). This will have many more Americans thinking about estate taxes as the sunset creeps nearer. For most, this will include establishing a trust.

It is true that proper trust planning can yield protections against estate tax, but a new revenue ruling clarifying existing law as it applies to the transfer of assets to an irrevocable trust might carry an unpleasant surprise for a trust’s beneficiaries. Before clients revise their estate plans, they should understand the effect that this revenue ruling might have on their heirs.

Rev. Rul. 2023-2 clarifies which assets transferred by a decedent to a beneficiary receive the coveted stepup in basis to fair market value under Sec. 1014 and which do not. The IRS concluded that no step-up in basis is available for assets in an irrevocable trust where the individual creating the trust retains a power that causes the individual to be the owner of the entire trust for income tax purposes but does not cause the trust assets to be included in the individual’s gross estate. (For further coverage of this revenue ruling, see Ransome, “Recent Developments in Estate Planning: Part 1,” 54-10 The Tax Adviser 26 (October 2023); and Trieu, “IRS Signals It Will Challenge IDGT Basis Step-Up at Death,” 54-9 The Tax Adviser 7 (September 2023)).

Rev. Rul. 2023-2

The starting point for the IRS’s analysis in the revenue ruling was Sec. 1014(a). That provision states 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 shall, if not sold, exchanged or otherwise disposed of before the decedent’s death, be … the fair market value of the property at the date of the decedent’s death” (or, in in the case of an election under Sec. 2032 or 2032A, the value determined under that section). Therefore, property acquired or passed from a decedent receives a basis step-up.

Sec. 1014(b) defines seven types of property as having been acquired or passed from a decedent, which can be summarized as falling into three broad categories:

• “Property acquired by bequest, devise or inheritance, or by the decedent’s estate from the decedent” (Sec. 1014(b)(1); see also Sec. 1014(b)(4) and (5));
• “[T]he surviving spouse’s one-half share of community property held by the decedent and the surviving spouse … if at least one-half of the whole of the community interest in such property was includible in determining the value of the decedent’s gross estate” (Sec. 1014(b) (6)); and
• Other property includible in the gross estate of the decedent under Sec. 2001 or 2044 (Secs. 1014(b)(2), (3), (9), and (10)).

The IRS first discussed whether the assets that a beneficiary receives from a decedent’s trust would be considered “bequeathed,” “devised,” or “inherited.” The U.S. Supreme Court, in Merriam, 263 U.S. 179 (1923), defined “bequest” as a “gift of personal property by will,” the IRS explained. A “devise” is considered the equivalent but used most often for real property, per Black’s Law Dictionary (11th ed. 2019) and Vol. 97 of Corpus Juris Secundum. Black’s further defines an “inheritance” as “property received from an ancestor under the laws of intestacy or property that a person receives by bequest or devise.”

So, was the property received from a decedent’s trust either bequeathed, devised, or inherited? Relying on Bacciocco, 286 F.2d 551 (6th Cir. 1961), and the legislative history of Sec. 1014, the IRS concluded that it was not. The property was transferred in trust prior to the decedent’s death; therefore, it was not bequeathed, devised, or inherited because it did not pass by will or intestacy.

Does this mean any property transferred from a decedent’s trust is not granted a stepped-up basis in the hands of the beneficiary? No, but according to Rev. Rul. 2023-2, we must look to the remaining two broad categories of property considered to be acquired or passed from a decedent under Sec. 1014(b). These two categories have one thing in common: To be considered property acquired or passed from a decedent, the property must be includible in the gross estate of the decedent for estate tax purposes. The Service concluded that neither of these categories applied here as well.

In sum, there was no step-up in basis because the assets in the trust were not acquired or passed from a decedent as defined in Sec. 1014(b). Consequently, the basis of the assets immediately after the grantor’s death was the same as the basis immediately before the grantor’s death, the IRS concluded.

Implications of the revenue ruling

In estate planning, two basic types of trusts are used to move assets from a trustor to a beneficiary: revocable and irrevocable. A revocable trust is one in which the grantor retains the right to make significant changes to its terms, including taking the property back out and terminating the trust. As a result of the grantor’s control over the assets of a revocable trust, the assets would be included in the grantor’s taxable estate upon death. Accordingly, any assets later distributed to the beneficiaries of a revocable trust would enjoy the Sec. 1014 step-up in basis.

Example: D transfers all of his assets to his revocable living trust. D’s basis in the assets was $3 million. Upon his death in 2026, the trust distributes all his assets to his only child, O. At the time of D’s death, the trust assets were valued at $7 million. Assuming no change in current law delaying the sunset of the expanded unified credit, D’s gross estate would report $7 million of assets and pay any tax after the unified credit is applied. Immediately upon receiving the assets, O sells them for $7.2 million and reports a taxable gain of only $200,000.

In contrast, the grantor of an irrevocable trust generally does not enjoy the same control over trust assets during their lifetime. Although they may maintain some limited powers, they cannot make large, sweeping changes, recall the property, or end the trust without court intervention. As a result, the assets of an irrevocable trust would generally not be included in the grantor’s taxable estate upon death unless the powers retained by the grantor were so significant that it was essentially deemed to be the equivalent of a revocable trust for purposes of valuing the gross estate. For the purposes of this discussion, assume this is not the case. Consequently, any assets later distributed to the beneficiaries of most irrevocable trusts would not benefit from the Sec. 1014 step-up in basis.

Revisit the previous example, except this time, D transfers all his assets to an irrevocable trust in which he does not maintain any significant control over the trust assets. D’s basis in the assets was $3 million. Upon his death in 2026, the trust distributes all his assets to O. At the time of D’s death, the trust assets were valued at $7 million. D’s gross estate is of minimal value because he transferred all his assets to the irrevocable trust, and no estate tax would be assessed. Immediately upon receiving the assets, O sells them for $7.2 million and reports a taxable gain of $4.2 million.

Does this mean clients should abandon the use of irrevocable trusts? Of course not. Depending upon the size of their estate, as well as other factors, including the need for asset protection, privacy, probate avoidance, and estate tax planning, an irrevocable trust may still be the best answer. However, in making their estate plan decisions, it is essential for clients to understand all the consequences, including any potential effect upon their beneficiaries, to ensure that the desired outcome is achieved without any unpleasant surprises to their loved ones after they’re gone.

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Cook at mcook@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.