The IRS's Revenue Ruling 2023-2, issued in March, significantly impacts estate planning, particularly in relation to irrevocable trusts. In recent years, families have increasingly utilized these trusts to safeguard their assets from spend-down, thereby helping to qualify for government benefits such as Medicaid and VA Aid and Attendance. Before this ruling, there was uncertainty about whether assets bequeathed through an irrevocable trust would benefit from a step-up in basis, which could negate any capital gains taxes that might otherwise be due. Traditionally, assets disposed of during a person's lifetime are subject to capital gains taxes on the increase in asset value over time. However, a step-up in basis applies when assets are transferred upon the owner's death, nullifying any capital gains taxes.
Concerns persisted about assets in irrevocable trusts because they are neither held by the asset purchaser nor passed to beneficiaries. Before March 2023, these trust assets typically received a step-up in basis upon death. However, the new IRS ruling states that property within an irrevocable trust, not included in the taxable estate at death, will no longer receive a step-up in basis.
This change could lead to the assumption that planning with irrevocable trusts could subject beneficiaries to additional taxes. The motivation for using such trusts often relates to the high cost of long-term care, which averages $6,500 to $10,000 per month. Few families can afford this without depleting their savings, hence the need to resort to Medicaid or VA Aid and Attendance. However, qualifying for these programs requires a spend-down of assets to a level set by the state, with irrevocable trusts being one of the few ways to protect against this.
The IRS ruling might suggest that beneficiaries could face additional taxes. The key element is that assets held in an irrevocable trust, not otherwise included in your estate at death for tax purposes, will lose the step-up in basis. This implies that an intention to subject as many estates as possible to estate taxes could result if trusts are not set up correctly.
Nevertheless, properly setting up an irrevocable trust can include trust assets in the taxable estate at death, thus exempting most families from estate taxes. As a result, assets can be protected from long-term care spend-down, avoid capital gains and estate taxes, and be passed to beneficiaries tax-free with careful planning.
Consider a couple, Tom and Jane, who bought a home in 1975 for $100,000. If it's now worth $250,000 and sold, they owe capital gains on the $150,000 increase in value. If transferred to an irrevocable trust before March 2023, the trust could sell the house from a cost basis of $250,000 due to the step-up in basis, eliminating capital gains when the proceeds are distributed to Tom and Jane's children. But post-Revenue Ruling 2023-2, the trust needs to be appropriately worded to ensure the home's value is included in their taxable estate; otherwise, their children will owe capital gains of $150,000.
Most families, when including their home value, will not be subject to estate tax, as the current federal estate tax only applies to estates valued at $12.92 million or more. However, it's more likely to affect families when the estate tax limit is reduced in 2026. Those considering or currently using an irrevocable trust should seek legal advice from an attorney specializing in elder law and estate planning, ideally involving a tax professional. Despite the increasing complexity of tax laws, careful advice and planning can secure advantageous outcomes for you and your children.
Talley's team of tax professionals provides comprehensive tax compliance and consulting services so you can preserve, enhance, and pass on your assets and wealth to the next generation. We welcome the opportunity to discuss the current options available for you. For more information, contact us today.