Oh no! Not Revenue Ruling 2023-2!
November 1, 2023 | View PDF
The most interesting thing about Twitter is that they changed their name to “X” and yet the ZZ Top song, “I Heard it on the X” has not been trending. But that has nothing to do with my topic today, so I’ll move on.
The second most interesting thing about Twitter is that you get these conversations among experts in a particular field, but people who don’t know anything about that field get to wander in and out of the conversation. That can be fun, but it also leads to confusion and misinformation.
Recently the IRS issued Revenue Ruling 2023-2, regarding taxation of trusts. A Revenue Ruling is an opinion from the agency about how to interpret a tax law. In this case, the ruling created a lot of buzz amongst tax experts. And unfortunately, because online they are mostly talking to each other, and having to do so in short bursts of text, they are saying things which mislead non-tax experts.
So as someone who, while not a tax expert per se, is at least tax expert-adjacent, let me try to clear this up. Because I have been getting inundated with panicked calls about what this ruling means.
Before I start, let me explain that this is about something called the “automatic step up in basis on death”. It is a capital gains thing. Normally when you buy something, and then later you sell it for more, you pay capital gains tax. The tax is a percentage of the profit you made on the sale, and it is a fairly simple calculation. You take the net proceeds from the sale—what you got after sales costs—and then you subtract the “basis,” which in most cases is what you paid for that asset.
For example, if I bought a piece of land for $50,000, and then later I sold it and received $80,000, I would have a profit of $30,000. If I was in a 15% bracket for capital gains tax, I would pay $4,500 in tax on that sale.
But what happens if, after buying that piece of land, I died and my children inherited the property, and then they sold the property? Obviously they would have to pay the same capital gains tax, right? Wrong. When I died, the basis in the property—remember, that’s the amount that is subtracted from the proceeds—reset at the value of the property on the date of my death. So if the property was worth $80,000, and my kids turned around and sold it for that amount, they wouldn’t have to pay any capital gains tax. If they waited a year, and then it sold for $90,000, they would only pay capital gains tax on that extra $10,000.
That is a pretty nifty tax break. And as long as they get it on my death, they get that “step up”. It doesn’t matter if the property goes through probate, or if I leave it to them through a transfer-on-death deed, or if they get it through my revocable living trust. Either way, they get the tax break.
Which brings us to this new Revenue Ruling. A lot of the tax people on Twitter (and to be fair, a lot of other places on the internet) were saying that “the IRS has eliminated the step up in basis for grantor trusts!” And that has caused a lot of my clients, who have grantor trusts, to think that they just lost a significant tax benefit for their heirs. (A grantor trust is one in which the income of the trust is taxed directly to the person who created the trust.)
Except that really isn’t accurate. The Revenue Ruling only relates to a very specific type of grantor trust. They are denying the step up in basis for irrevocable grantor trusts.
But the vast majority of people who have grantor trusts have revocable—not irrevocable—living trusts. Nothing about the new Revenue Ruling takes away the step up in basis for your regular, run-of-the-mill revocable living trust.
Irrevocable grantor trusts are used by the lawyers who handle really big estates, which are subject to estate tax. In other words, their clients have more than $13 million for a single person or $26 million for a couple. A lot of them were creating these irrevocable trusts in which the income was taxed back to the creator of the trust, in order to freeze the value of the assets, for estate tax purposes, at the value the asset had at the time it was transferred to the trust. But at the same time they were trying to get the step up in basis for capital gains tax. Revenue Ruling 2023-2 just says that they can’t have it both ways.
So, if you think you might have an irrevocable grantor trust, by all means call your tax attorney or accountant and find out. But in all likelihood, that living trust you have is still going to get that favorable capital gains tax treatment.
So relax already.
Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. I would say something clever here but Senior Voice, like Twitter, has a word limit.