Grantor Trusts are Not Eligible for Step-Up? Say What!

In the last few months we have had a few phone calls from clients about a recent IRS revenue ruling (specifically, Revenue Ruling 2023-2). The question is always basically this: “A friend of mine heard that now my kids will have to pay taxes on the house they inherit from me when I pass away; is this true?” Most often this question comes from clients that have done Medicaid planning. To keep the answer short and to the point, this revenue ruling does not impact our average Medicaid planning client, and no, your beneficiaries will not have to pay taxes on the house they inherit from you.

This revenue ruling is specifically designed to tax individuals who are creating irrevocable trusts to transfer assets out of their estate to protect them from estate taxes, a strategy that was being employed by some individuals with a net worth of more than twelve million dollars. For more details, see below.

Did I just cause you to ask a separate question, like, what is Medicaid planning? Medicaid pre-planning in our office is helping clients prepare for the possible costs of long-term care. If you do not have a plan for how to cover the costs of long-term care and this is a concern of yours, give our office a call and we can schedule a review. During that review, we will go through all your long-term care planning options and try to give you a clearer vision of this possible future.

The More Details

Revenue Ruling 2023-2 is very short. The IRS said that if there is a completed gift to an irrevocable trustor (grantor) trust, the Trust will not receive a basis step-up upon the death of the grantor. The IRS comes to this conclusion because they say the property is not “acquired from a decedent” for purposes of Section 1014(a) of the Internal Revenue Code of 1986, as amended (the “Code”), as described in Section 1014(b) of the Code, they argue property is acquired from the trust and this means no step-up.

Assets received from a decedent get a basis step-up under Code Section 1014 generally because they are owned by the descendent at the time of their death and are passed on to a beneficiary. The logic for this step-up is that these assets are included in the taxable estate of a decedent and since they are subject to inheritance tax are provided a step-up in basis. Prior to this Ruling, many practitioners wondered whether the assets of an irrevocable grantor trust would be eligible for the same benefit since the goal of the trust was to exclude those assets from the estate. This new ruling makes the answer clear: no, they do not get the step-up.

What protects our Medicaid trusts from this ruling? The granting of a general power of appointment and/or the inclusion of trust assets in the estate of the grantor. This act allows allows for a Section 2038 step up in basis at death of the trustor (grantor). In other words, a full step-up in basis at the death for the beneficiaries is still achieved in a Medicaid trust.