Irrevocable Trusts and Step Up in Basis

A recent Internal Revenue Service revenue ruling has finally settled the debate over whether the assets in an irrevocable grantor trust can get a step-up in basis at the grantor’s death. Revenue Ruling 2023-2 makes clear that there’s no step-up in basis.

For years, practitioners have anticipated guidance from the IRS as to whether assets held in an irrevocable grantor trust that were removed from the grantor’s estate for federal estate tax purposes, but which remained taxable to the grantor for income tax purposes under Internal Revenue Code Sections 671-679, could receive a step-up in basis on the grantor's death. Some commonly refer to such trusts as “grantor trusts,” “intentionally defective grantor trusts” or “IDGTs.” These trusts are popular, in part, as an “estate tax freeze” because such trusts can remove the appreciation on assets held by the trust that occurs after the assets are gifted or acquired by the trust from federal estate taxation at the grantor’s death.

An additional reduction in the size of the grantor’s estate also results from the “tax burn” associated with the grantor’s obligation to personally report and be responsible for income tax consequences of such a trust. That’s because the grantor’s payment of the income tax isn’t treated as an additional gift.