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By Lindsay N. Graves, Esq., Kiplinger’s Consumer News Service (TNS)
In March, the IRS issued Revenue ruling 2023-2, which had a significant impact on estate planning, particularly when it came to irrevocable trusts. In the past decade or so, more families have begun using irrevocable trusts to protect their spending assets in order to qualify for government benefits, such as Medicaid and VA Aid and Attendance.
Prior to this ruling, it was not clear whether assets passing to beneficiaries through an irrevocable trust would receive an increase in principal, thus eliminating any capital gains taxes that might otherwise be due. Historically, assets disposed of during an individual’s lifetime are subject to capital gains taxes on the increase in the value of that asset over time. The amount of capital gains payable is determined largely by the difference between the value at the time of purchase and the value at the time of transfer.
The exception to the capital gains tax liability was when, upon the owner’s death, the assets passed to the beneficiaries. The death of the owner gives the beneficiaries an increase in the principal, so they inherit the asset as if it had been originally purchased Present Fair market value, not the value at the time the asset was actually purchased. This cancels out any capital gains and therefore no taxes become due.
What about an irrevocable trust?
But what do you do about the assets in an irrevocable trust? It is not currently held by the purchaser of the asset, and has not been transferred to the beneficiaries. Prior to March 2023, such death trust fund transfers generally received a escalation at baseline. But this may not be the case anymore. This new ruling from the IRS states that the property is owned by an irrevocable trust Which are not included in the taxable estate upon death You won’t receive a step-up basically anymore.
At first glance, it appears that anyone who schemes an irrevocable trust will subject their children to additional taxes. You might be wondering why anyone would chart an irrevocable trust in the first place. And as Americans get older and live longer, more of them find themselves in need of long-term care that averages $6,500 to $10,000 per month, depending on where you live and what level of care you need.
Very few families can pay that out of pocket without depleting their life savings, which means turning to programs like Medicaid or VA Aid and Attendance to help defray the cost. However, before you can qualify for such programs, you are expected to spend your assets to the level determined by your state of residence. One of the only tools that can protect assets from being spent is an irrevocable trust.
Does planning to protect assets now mean that to avoid spending, you will have to subject your children to additional taxes? maybe. The key part of the IRS decision is that only those assets held in an irrevocable trust that are not included in your estate upon death for estate tax purposes will lose the basis. What does it mean? Essentially, in a move likely aimed at making sure that as many properties as possible become subject to payment Property Taxes If you set up an Irrevocable Trust and it is not set up properly, you will lose the essential step.
It is important how to create an irrevocable trust
However, it is possible to create an irrevocable trust that allows any assets from the trust to be included in taxable property upon death – keeping in mind that most families, even with their home value included, would not have an estate large enough to be subject to estate taxes. Thus, your assets can be protected from spending due to long-term care, avoid capital gains and estate taxes and pass on to your children tax-free. It takes very careful planning.
For example, let’s look at the couple we’ll call Tom and Jane. Tom and Jane bought a home in 1975 for $100,000. If this house is now worth $250,000 and they sell that house, they will owe capital gains taxes on the $150,000 growth. In contrast, had Tom and Jane transferred their home to an irrevocable trust before March 2023, the trust would have sold the home at a cost of $250,000, not $100,000 (due to the principal increase), so there would be no A capital gain will be due when the trust then distributes those proceeds to Tom and Jane’s children. Post-Revenue Rule 2023-2 Unless the trust is properly drafted to ensure that the $250,000 home value is included in Tom and Jane’s taxable estate, the children will owe $150,000 in capital gains.
Most families won’t find themselves subject to an estate tax when their home value is included because the current federal estate tax only applies to properties valued at $12.92 million or more. This will be most likely to affect families when the estate tax limit is cut in 2026 to about half of that exemption amount. (For more on this, see the article Provisions of the Tax Cuts and Jobs Act may expire soon.)
If you currently have an irrevocable trust or are interested in learning more about it, seek legal advice from an attorney familiar with both senior law and estate planning. It’s also always a good idea to get your tax professional involved in the conversation so you don’t miss out on anything in your plan.
The world has gotten more complicated, and so have tax laws, but you (and your kids) can still come up with sound advice and planning.
About the author
Lindsay N. Graves, Esq., is the co-founder of Graves Law Firm.
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All content is copyright 2023 Kiplinger Washington Editors Inc. and distributed by Tribune Content Agency LLC.
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