In 2023, the United States Internal Revenue Service (the “IRS”) issued a revenue ruling concerning irrevocable grantor trusts and whether the assets held in such trusts receive a step up in basis when the taxpayer dies. This revenue ruling has caused tremendous consternation among accountants; I know because two of my former clients’ accountants recently called me with questions related to this revenue ruling.

A revenue ruling from the IRS is essentially a legal memorandum that the IRS issues on a given tax issue. Revenue rulings are called “rev. rulings” for short. The rev. ruling in question is called 2023-2, meaning it was the second rev. ruling the IRS issued in 2023.

A “trust” is a fiduciary relationship through which one person, the trustee, holds assets for the benefit of another person, the beneficiary. The person who places her assets in the trust is called the “grantor.”  An “irrevocable trust” is a trust instrument the terms of which the grantor cannot revoke or modify.

An irrevocable “grantor trust” (or an “intentionally defective grantor trust”) is a trust the income, deductions, and credits from which are still taxable to the grantor. For example, Mrs. Smith transfers $300,000 of her money into an irrevocable grantor trust. The trustee of the trust, her son, invests the $300,000 in CDs. The CDs earn $10,000 of interest every year. Someone has to pay income tax on this $10,000. If the trust is a grantor trust, then Mrs. Smith will still pay the income tax on the $10,000 interest even though she transferred the money to an irrevocable trust. If the irrevocable trust is not a grantor trust, then the trust will have to pay tax on the income the trust generates.

A grantor trust is called an “intentionally defective grantor trust” because in many cases, Mrs. Smith (as grantor) drafts the trust so that the income is taxable to her, not the trust. She makes the trust “intentionally defective,” so the income is still taxable to her.

Mrs. Smith can make the trust intentionally defective by retaining certain rights in the trust property—for instance, if Mrs. Smith retains the right to reacquire the property in the trust (the $300,000) by substituting other property of equivalent value (say, stocks worth $300,000), then the trust will be deemed to be a grantor trust and the income of the trust will be taxable to Mrs. Smith.  A taxpayer may want to make a trust intentionally defective because trusts are often taxed at higher effective rates than individuals.

When a person dies, the assets that the decedent owned at the time of death receive a step up in basis. For instance, assume Mrs. Smith purchased her home for $50,000 in 1980. Mrs. Smith dies in 2024 owning the same home. In 2024, the home has a value of $600,000. When her children—the beneficiaries of her estate—inherit her home, the children will receive the home with a basis of $600,000. When the children sell the house, they will not pay any tax on the sale because their basis in the home ($600,000) will equal the sales price ($600,000); there is no gain so there is no tax.

Revenue ruling 2023-2 answers the following issue: Is there a step up in basis for assets owned in an irrevocable grantor trust if the assets are not includible in the grantor’s estate at the time of death? Quite frankly, this revenue ruling fails to move the ball forward on any issue. The simple answer is, of course there is no step up in basis in such a circumstance. Assets have to be includible in the grantor’s estate at the time of death in order for the assets to receive a step up in basis.

But rev. ruling 2023-2 also does not mean that assets held in any irrevocable grantor trust fail to receive a step up in basis. If there are reasons why the assets held in the trust are includible in the grantor’s estate, then the assets receive a step up in basis.

For instance, if Mrs. Smith transfers her home to a trust but retains life rights in her home, the right to live in the home for the remainder of her life, the retained life rights would include the house in Mrs. Smith’s estate so the house receives a step up in basis even if the remainder interest in the home is owned in an irrevocable grantor trust.  In my opinion, revenue ruling 2023-2 just restates the law that has existed for at least as long as I have practiced elder law.