IRS Announcement Casts a Cloud of Uncertainty on the Tax Treatment of Intentionally Defective Grantor Trusts

IRS Announcement Casts a Cloud of Uncertainty on the Tax Treatment of Intentionally Defective Grantor Trusts

Intentionally Defective Grantor Trusts, or IDGTs, are popular estate planning tools. For estate tax purposes, the value of the assets transferred to the IDGT are treated as removed from the taxpayer’s gross estate.   But for income tax purposes, the taxpayer is still treated as the owner of the transferred assets and must pay taxes on the income derived therefrom.   This differing treatment begs the question:   are assets held in an IDGT subject to adjustment under Section 1014 (marking the bases in those assets up to fair market value) when the taxpayer passes away, despite the non-inclusion of those assets in the taxpayer’s gross estate?

While  many tax practitioners contend the answer to this question is “yes,” the IRS has hinted at a potentially different answer.  Earlier this week the IRS added to its “no ruling” list this very issue, i.e.,  “Whether the assets in a grantor trust receive a section 1014 basis adjustment at the death of the deemed owner of the trust for income tax purposes when those assets are not includible in the gross estate of that owner under chapter 11 of subtitle B of the Internal Revenue Code.”   Based on our tax litigation experiences, this move by the IRS may be seen as a “shot across the bow,” to be followed by perhaps IRS guidance or a formal litigation position that is not taxpayer friendly and designed to test tax practitioner wisdom in this area.  

While many will debate whether the IRS’ announcement significantly increases the stakes of claiming a Section 1014 basis adjustment to IDGT assets, one thing is certain:   the IRS has added unwelcomed uncertainty to this popular planning technique. 

To view the IRS’ s announcement (Rev. Proc. 2015-37), follow this link:  http://www.irs.gov/pub/irs-drop/rp-15-37.pdf