United States: Basis Of Grantor Trust Assets At Death: What Treasury Should Do

Two years have passed since Treasury and the IRS first announced that they were working on guidance relating to the basis of grantor trust assets at death.1 The project is apparently approaching completion — although Treasury's 2017-2018 priority guidance plan omitted projects not expected to be completed by the end of plan year, the basis of grantor trust assets at death remains on the list.2 Guidance, in other words, was expected to be issued by the end of June.

It is not surprising that Treasury remains committed to settling once and for all how the basis of grantor trust assets is determined after the grantor's death. Irrevocable grantor trusts, as described below, have become perhaps the premier vehicle whereby affluent Americans pass wealth free of gift and estate tax to the next generation. On top of their considerable estate tax planning benefits, grantor trusts may even qualify for a step-up in basis at death,3 at least according to some attorneys and tax scholars.4 At the same time, the IRS has vehemently rejected the theory that grantor trust assets receive a basis step-up at death.5 The guidance project apparently aims to establish that grantor trusts do not receive tax-free step-up in basis when the grantor dies.

Yet Treasury and the IRS face significant technical obstacles to achieving their objective. For better or worse, the IRS's own prior rulings and regulations have interpreted the code in a way that leaves no obvious solution to the problem of how the basis of grantor trust property is determined at death. Further, any subregulatory guidance risks inadvertently contradicting prior guidance. To avoid that outcome, Treasury and the IRS might need to reassess and possibly revoke decades-old rulings.

Fortunately, there is a way out. Section 1015(b) is an ancient and seldom-cited section of the code. But though the law may sleep, it is not dead: By its terms, section 1015(b) provides an answer to the vexed question of how the basis of grantor trust assets is determined after death. Specifically, under section 1015(b), the assets of a grantor trust after death have the same basis, once grantor trust status is turned off, as they had before death. In other words, consistent with the IRS view that grantor trusts do not qualify for a step-up in basis at death, section 1015(b) imposes a carryover basis.

Moreover, if Treasury and the IRS do rely on section 1015(b) to determine the basis of grantor trust assets at death, prior guidance would not need to be revoked or revised. Indeed, the IRS would merely have to reiterate the position it has already taken in an earlier ruling, Rev. Rul. 2008-41, 2008-30 IRB 170, and apply it in a different but analogous context. For those reasons, we argue, Treasury and the IRS should issue a revenue ruling holding that section 1015(b) governs the basis of trust property after an irrevocable grantor trust converts to a non-grantor trust at the death of the grantor.

I. Advantages of Irrevocable Grantor Trusts

A grantor trust is a trust that is treated as owned by the grantor or another person for income tax purposes under the rules of sections 671 through 679. Importantly, a gift can be considered complete for gift and estate purposes but still be treated as incomplete for income tax purposes. A wealthy individual, for example, can make a gift6 to an irrevocable trust that will not be included in the donor's gross estate at death under one of the estate tax "string" sections.7 As a result, all future investment returns on trust property from the date of the gift pass free of gift and estate tax.8

Even though the trust property passes outside the donor's gross estate for estate tax purposes, the trust can still be drafted as a grantor trust that is treated as owned by the donor for income tax purposes. For example, the grantor may retain the power (in a nonfiduciary capacity) to substitute property of an equivalent value9 or may give a non-adverse person a power to make loans to the grantor for less than adequate interest or security.10 Other techniques for triggering grantor trust status include designating the donor's spouse as a permissible beneficiary of the trust,11 granting a power to expand the class of beneficiaries,12 appointing a related or subordinate party as trustee,13 or having the trust acquire life insurance policies on the grantor's life whose premiums can be paid out of the income or principal of the trust.14 Even merely borrowing from the trust (or having the grantor's spouse borrow from the trust15) at some point during the year may cause grantor trust status for the entire year.16

With grantor trust status achieved, several estate tax planning techniques become possible. Perhaps the most powerful is simply the donor's obligation under the code to pay the tax on the grantor trust's income. The shift of tax liability from the trust to the donor allows the trust to earn tax-free returns during the donor's lifetime, even as the donor's own estate is depleted. Despite the significant — oftentimes massive — transfers of wealth that thereby occur, the donor is not treated as having made additional gifts to the trust for gift tax purposes.17

Another technique is to sell assets that will earn returns that exceed those earned on the consideration received. For example, the donor could sell assets to an irrevocable grantor trust in exchange for a promissory note bearing interest at no more than the applicable federal rate. If the value of the property transferred by the donor is equal to the value of the property received (that is, the note), no gift occurs for gift tax purposes.18 Further, under section 7872, the value of the note is not discounted to reflect the relatively low interest rate.19 Thus, the sale succeeds in passing wealth to the trust free of gift and estate tax as long as the assets earn returns that exceed the low interest rate.

Meanwhile, the IRS has for decades taken the position that grantor trusts are ignored for all income tax purposes.20 The sale, therefore, is ignored for income tax purposes and the grantor recognizes neither gain on the sale nor interest income on the note.21 In short, through a sale to a grantor trust, a wealthy individual can freeze the value of property transferred to a trust and cause future investment returns (above a relatively low interest rate) to pass to descendants, all without gift, estate, or income tax cost.

To read this article in full, please click here.

Footnotes

1. See Treasury 2015-2016 priority guidance plan.

2. See Treasury 2017-2018 priority guidance plan and quarterly updates.

3. As discussed below, section 1014(a) generally provides that property acquired or passing from a decedent receives a basis equal to its fair market value on the date of the decedent's death or the alternate valuation date, if the estate tax alternate valuation date election is made. As most property tends to appreciate, and well-advised taxpayers typically realize losses before death, the fresh basis at death under section 1014(a) is commonly referred to, including in this article, as a basis "step-up."

4. Jonathan G. Blattmachr, Mitchell M. Gans, and Hugh H. Jacobson, "Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor's Death," 97 J. Tax'n 149 (2002).

5. ECC 200937028.

6. Reg. section 25.2511-2. A gift is complete for gift tax purposes if the donor "has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another." Reg. section 25.2511-2(b).

7. Sections 2035-2039 and 2041.

8. The code gives the IRS no mechanism for taxing future outsized returns earned by the donee of the gift. See reg. section 25.2511-2(a) ("The gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer.").

9. Section 675(4); see also Rev. Rul. 2008-22, 2008-16 IRB 796.

10. Section 675(2).

11. Section 677(a)(1).

12. Such a power, combined with trustee discretion to make distributions, may cause grantor trust status under section 674(a) by negating the otherwise broad exception of section 674(c).

13. Like a power to add to the class of beneficiaries, the appointing of a related or subordinate party as trustee may cause grantor trust status under section 674(a) by negating the otherwise broad exception of section 674(c).

14. Section 677(a)(3); Rev. Rul. 66-313, 1966-2 C.B. 245.

15. Section 672(e).

16. Rev. Rul. 86-82, 1986-1 C.B. 253.

17. Rev. Rul. 2004-64, 2004-2 C.B. 7.

18. Section 2512(b); reg. section 25.2512-8.

19. See LTR 9535026 (holding that the value of secured notes bearing interest at the rate prescribed by section 7872 of the code was equal to the value of the property transferred); cf. LTR 9644053 (holding that a secured right to an annuity was equivalent in value to the property transferred); see also reg. section 25.2504-2(d), Example 3; Frazee v. Commissioner, 98 T.C. 554, 590 (1992); True v. Commissioner, T.C. Memo. 2001-167. But see Dallas v. Commissioner, T.C. Memo. 2006-212 (valuing promissory notes with self-canceling provisions at less than the value of the property sold).

20. ILM 201343021 ("We conclude that a trust that is treated as a grantor trust is ignored as a separate entity apart from the owner for all federal income tax purposes."); Rev. Rul. 85-13, 1985-1 C.B. 184; Rev. Rul. 2007-13, 2007-1 C.B. 684. Cf. reg. section 1.1001-2(c), Example 5 (stating that the grantor of a grantor trust "is treated as the owner of the entire trust"); but see Rothstein v. United States, 735 F.2d 704 (2d Cir. 1984).

21. Rev. Rul. 85-13.

Originally published by Tax Notes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions