Rev. Rul. 2023-2 and the Basis Step-Up in Irrevocable Grantor Trusts

Rev. Rul. 2023-2 clarified an important point of law regarding the interaction between Section 1014 of the Internal Revenue Code and assets transferred to irrevocable grantor trusts by completed gift. Specifically, the IRS ruled that the basis “step-up” under Section 1014 does not apply to assets transferred to an irrevocable grantor trust by completed gift when those assets are not included in the gross estate of the grantor for federal estate tax purposes. This ruling underscores the critical importance of understanding the tax implications of trust design, especially as it pertains to estate planning and asset protection strategies.

The Basis Step-Up under Section 1014

Section 1014 provides for a step-up in the basis of property to its fair market value (FMV) at the date of the owner’s death if the property is includable in the decedent’s gross estate for federal estate tax purposes. This step-up in basis can significantly reduce capital gains tax liability for heirs when they sell inherited assets.

However, for assets that are not includable in the gross estate, the step-up in basis does not apply. Instead, the assets retain the grantor’s original basis, potentially leading to a higher capital gains tax burden upon disposition.

Irrevocable Grantor Trusts and Completed Gifts

In Rev. Rul. 2023-2, the IRS analyzed the treatment of assets transferred to an irrevocable grantor trust via a completed gift. For a gift to be complete, the grantor must relinquish all control and beneficial interest over the asset. If such an irrevocable trust is structured so that the assets are excluded from the grantor’s gross estate, the basis step-up under Section 1014 does not apply. The ruling confirms that, in such cases, the assets will retain their original basis, even though the trust remains a grantor trust for income tax purposes.

The Bridge Trust: A Key Distinction

The Bridge Trust® represents an alternative type of irrevocable grantor trust, designed to provide asset protection while maintaining inclusion in the grantor’s gross estate. Unlike the irrevocable grantor trust discussed in Rev. Rul. 2023-2, the Bridge Trust does not require a completed gift to achieve its objectives. Instead, it is structured so that the grantor retains certain powers or interests that result in the trust assets being includable in the grantor’s estate for federal estate tax purposes.

Because the Bridge Trust ensures that the assets remain part of the grantor’s estate, the basis of these assets is stepped up (or stepped down) to their FMV at the time of the grantor’s death, pursuant to Section 1014. This feature makes the Bridge Trust a powerful tool for achieving both tax efficiency and robust asset protection.

Key Features of the Bridge Trust:

1. Estate Tax Inclusion: Assets held in the Bridge Trust are includable in the grantor’s gross estate, qualifying them for the step-up in basis.

2. Grantor Trust Status: For income tax purposes, the grantor is treated as the owner, enabling efficient income tax treatment.

3. Asset Protection: The trust provides a high level of protection against creditors, often comparable to offshore asset protection trusts.

4. Flexibility: The Bridge Trust can be toggled between domestic and offshore jurisdictions to adapt to changing circumstances or legal challenges.

Comparing the Two Trust Types

Feature	Irrevocable Grantor Trust (Completed Gift)	Bridge Trust
Gift Status	Completed gift	Incomplete gift
Estate Tax Inclusion	Not includable	Includable
Basis Step-Up at Death	Not applicable	Applicable
Asset Protection	High	High
Flexibility	Typically static	Highly flexible

Conclusion

Rev. Rul. 2023-2 highlights the critical distinction between irrevocable grantor trusts that exclude assets from the gross estate and those that retain estate inclusion, such as the Bridge Trust. For individuals seeking to balance asset protection, tax efficiency, and estate planning objectives, understanding these nuances is essential. While traditional irrevocable grantor trusts may offer certain advantages in lifetime planning, the Bridge Trust provides a unique combination of benefits, ensuring both the step-up in basis under Section 1014 and robust asset protection. As always, consulting with a qualified estate planning attorney or tax professional is vital to tailor trust structures to individual circumstances and goals.