Understanding the Impact of Recent IRS Ruling on Trusts and Estate Planning

Estate planning just got a bit more complicated, thanks to a recent ruling by the IRS. The ruling was issued in March 2023 and is Revenue Ruling 2023-2; it has significant implications for individuals who have an irrevocable trust as part of their estate plan. In recent years, more and more families have turned to irrevocable trusts to safeguard their assets from being depleted in order to qualify for government benefits such as Medicaid.

So why is this ruling important? Prior to its issuance, there was uncertainty regarding whether assets passing to beneficiaries through an irrevocable trust that removes the assets from the grantor’s taxable estate would receive a step-up in basis. A step-up in basis eliminates the capital gains taxes that would otherwise be owed when disposing of an asset upon the grantor’s death. Normally, if you sell an asset during your lifetime, you have to pay capital gains taxes on the increase in its value. The difference between the purchase price and the selling price determines the amount of tax owed.

However, when assets pass to beneficiaries at the owner’s death, they receive a step-up in basis. This means that the beneficiaries inherit the asset at its current fair market value (i.e. the fair market value at the time of death), effectively erasing any potential capital gains taxes.

But what happens when the assets are held in an irrevocable trust? Until recently, these transfers from the trust at the owner’s death usually received a step-up in basis. However, the IRS ruling states that property held in an irrevocable trust that is not included in the taxable estate at death will no longer receive a step-up in basis.

At first glance, it might seem like those who utilize irrevocable trusts are subjecting their children to additional taxes. But before jumping to conclusions, it’s essential to understand the context. As Americans age and require long-term care, the costs can be substantial, ranging from $12,000 to $18,000 per month in New York (and about $6,000 to $10,000 is the national average). Most families cannot afford this without depleting their savings, which is why they turn to programs like Medicaid. However, to qualify for such a program, they must go through a spend-down process that requires reducing their assets to a certain level set by the state.

An irrevocable trust is one of the few tools available to protect assets from this spend-down process. So does this mean that asset protection planning forces families to subject their children to additional taxes? Not necessarily. The key aspect of the IRS ruling is that only assets held in an irrevocable trust that are not included in the taxable estate at death will lose the step-up in basis. This means that establishing an irrevocable trust that includes all the assets in your taxable estate can still offer protection while preserving the step-up in basis.

If you currently have an irrevocable trust or are interested in learning more about one, it’s crucial to seek guidance from an attorney who specializes in elder law and estate planning. In addition, involving a tax professional in the conversation can help ensure that all aspects of your plan are considered.

The world of estate planning and taxes can be complex, but with the right advice and careful planning, you and your children can still benefit. Stay informed, seek expert help, and make the necessary adjustments to your estate plan to navigate these changes effectively. The Law Offices of Irina Yadgarova is uniquely poised to assist you with your elder and estate planning needs.