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IRS Revenue Ruling 2023-2: Implications for Irrevocable Trusts

IRS Revenue Ruling 2023-2: Implications for Irrevocable Trusts

May 16, 2024

In March 2023, the IRS issued Revenue Ruling 2023-2, marking a significant development in estate planning, particularly concerning irrevocable trusts. Over the past decade, families increasingly turn to irrevocable trusts to safeguard assets from spend-down, allowing them to qualify for government benefits like Medicaid and VA Aid and Attendance.

Historically, it remained uncertain whether assets passing to beneficiaries through irrevocable trusts would receive a step-up in basis, effectively eliminating capital gains taxes. Capital gains taxes typically apply when assets are disposed of during an individual’s lifetime, reflecting the increase in their value over time. However, at death, beneficiaries inherit assets with a step-up in basis, calculated at the current fair market value, thus avoiding capital gains taxes.

But what about assets in an irrevocable trust? Before March 2023, these assets generally received a step-up in basis. However, the new IRS ruling clarifies that property held in an irrevocable trust, not included in the taxable estate at death, will no longer receive a step-up in basis.

At first glance, this ruling might seem to subject children to additional taxes, raising concerns about the purpose of irrevocable trust planning. As longevity increases, so does the need for long-term care, with costs ranging from $6,500 to $10,000 per month. Many families turn to Medicaid or VA Aid and Attendance for assistance but must undergo asset spend-down to qualify. Irrevocable trusts are one of the few tools available to protect assets from spend-down.

However, not all irrevocable trusts are affected by the ruling. Those properly structured to include trust assets in the taxable estate at death, avoiding estate taxes, can retain the step-up basis. Most families with estates below the taxable threshold can protect assets from spend-down, capital gains taxes, and estate taxes, passing them tax-free to their children with careful planning.

Consider Tom and Jane, who bought a home in 1975 for $100,000, now valued at $250,000. Selling it would incur capital gains taxes on the $150,000 growth. With an irrevocable trust, the step-up in basis eliminates capital gains. However, without proper trust structuring, children may owe capital gains. Most families, though, won’t be affected by estate taxes, given the current exemption limit of $13.61 million.

If you have an irrevocable trust or are considering one, seek legal counsel from an attorney versed in elder law and estate planning and involve your financial professional to ensure a comprehensive plan. Despite evolving tax laws, sound advice and planning can ensure you and your children benefit in the long run. To discuss these issues in further detail, call our office to schedule an appointment.