IRS curbs tax break on irrevocable grantor trusts

The Internal Revenue Service issued a revenue ruling that aims to curb the abuse of stepped-up basis adjustments in irrevocable grantor trusts.

Revenue Ruling 2023-02, issued Wednesday by the IRS confirms that the basis adjustment under Section 1014 of the Tax Code generally doesn't apply to the assets of an irrevocable grantor trust not included in the deceased grantor's gross estate for federal estate tax purposes.

The IRS noted in an email that Section 1014 of the Internal Revenue Code doesn't apply to "step-up" the basis of assets gifted to an irrevocable grantor trust by completed gift in cases in which such assets are not included in the gross estate of the owner of the trust for federal estate tax purposes. In such cases, even though the grantor trust's owner is liable for federal income tax on the trust's income, the assets of the grantor trust aren't considered to be either acquired or passed from a decedent through a bequest, "devise," inheritance or otherwise within the meaning of Section 1014(b), and therefore Section 1014(a) doesn't apply.

A "devise" is given through a will instrument and can be a gift of real property like a house. 

According to an IRS FAQ page on abusive trust tax evasion schemes, an irrevocable trust is a trust, which, by its terms, can't be modified, amended or revoked. For tax purposes an irrevocable trust can be treated as a simple, complex or grantor trust, depending on the powers listed in the trust instrument. "State law and the trust instrument establish whether a trust is revocable or irrevocable," the IRS noted. "If the trust instrument is silent on revocability, then most states consider the trust revocable."

Andrew Harrer/Bloomberg

Rep. Bill Pascrell, D-New Jersey, a member of the tax-writing House Ways and Means Committee, praised the action by the IRS and the Treasury Department and said it would curb abuse of stepped-up basis through the Tax Code. The action comes after he prodded the Treasury and the IRS to issue this guidance.

"Stepped-up basis might be the worst loophole in the entire federal tax code because it lets some of the richest people on earth pass along their inheritances without paying a dime," said Pascrell in a statement Wednesday. "The abuses of this billionaires' bonanza loophole cost taxpayers billions every year. For over a year, I have been calling for guidance to eliminate one of the most egregious maneuvers employed by wealthy tax cheats: claiming stepped-up basis for assets in irrevocable grantor trusts. Aggressive tax avoiders will be stopped in their tracks thanks to Secretary [Janet] Yellen and Commissioner [Daniel] Werfel cracking down on these abuses. This a win in the fight for fairer tax administration. Congress should take this opportunity to finally pass my legislation to close this crummy loophole for good."

The guidance clarifies that assets outside a taxpayers' estate in an irrevocable grantor trust generally do not qualify for stepped-up basis treatment under Section 1014. His office noted that a common estate-planning technique used by the wealthy is to transfer assets to an irrevocable grantor trust while the individual is still alive. The trust's property generally won't be included in the individual's gross estate at death, thereby avoiding the estate tax.

His office noted in a press release that some taxpayers have pursued strategies to aggressively avoid paying taxes by taking the position that the termination of an irrevocable grantor trust at the death of the grantor should also enable the assets to qualify for stepped-up basis treatment under Section 1014. The new guidance aims to end that strategy.  

When he chaired the House Ways and Means Oversight Subcommittee before control of Congress switched after the 2022 election, Pascrell convened an oversight hearing on how wealthy families increasingly transfer property for generations to avoid ever paying taxes on vast fortunes on Dec. 7, 2021. Testimony during the hearing showed how Americans have increasingly been favoring states like South Dakota and Wyoming over Switzerland and the Cayman Islands as their preferred tax havens to hide their money within U.S. borders.

In March 2022, he wrote a letter to Treasury Secretary Janet Yellen urging her to issue regulations on irrevocable grantor trusts to limit rampant exploitation of the Tax Code. Later, in June of last year, he pressed Yellen during her testimony before the Ways and Means Committee, asking for an update on when the guidance would be enacted. Last November, he welcomed the fact that the IRS had included guidance limiting irrevocable grantor trust abuse in its 2022-2023 Priority Tax Guidance Plan and called for swift implementation. He's also the longtime sponsor of legislation to close the stepped-up basis tax break and plans to reintroduce the bill in the near future.