Wills and Trusts

Wyatt, Tarrant & Combs, LLP


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MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part II

MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part II

Swapping Assets with Existing IDGTs

In 2011 and 2012, many individuals made significant taxable gifts, using all or a significant portion of their Available Exclusion Amounts because of the risk of that the exemptions would “sunset” back to 2001 levels.  Many of those gifts were made to grantor trusts.

A common power used to achieve grantor trust status for the IDGT is one described under section 675(4)(C), namely giving the grantor, the power, in a non-fiduciary capacity, to reacquire the trust corpus by substituting other property of an equivalent value.[1]  For income tax purposes, transactions between the grantor and the IDGT will be disregarded.[2]  As such, grantors may exercise the power to swap high basis assets for low basis assets without jeopardizing the estate tax includibility of the assets and without having a taxable transaction for income tax purposes.

To maximize the benefits of the swap power, it must be exercised as assets appreciate or are sold over time.  When exercised properly, this can ensure that only those assets that benefit the most from the step-up will be subject to estate inclusion.

If grantor does not have sufficient other assets, repurchase will be difficult – although the donor could borrow cash from a third party.

The income tax consequences if a note is used to repurchase property are uncertain because the trust’s basis in note may equal grantor’s original carryover basis in the asset given to the trust and now reacquired so paying off the note may generate gain).

Because the sudden or unexpected death of the grantor may make a repurchase difficult or impossible, estate planners may want to consider drafting “standby” purchase instruments to facilitate fast implementation of repurchase.

The Obama administration has proposed significant limitations on the ability of grantors to prospectively manage assets that would be includible in the grantor’s estate through the use of this swap power.  Pursuant to the proposal:

If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) will be subject to estate tax as part of the gross estate of the deemed owner, will be subject to gift tax at any time during the deemed owner’s life when his or her treatment as a deemed owner of the trust is terminated, and will be treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the deemed owner.[3]

The proposal would apply to pre-existing IDGTs because it would be effective with regard to trusts that engage in a described transaction on or after the date of enactment

Turney P. Berry

Louisville, Kentucky


[1]§ 675(4)(C) and Rev. Rul. 2008-22, 2008-16 I.R.B. 796.

[2] See Rev. Rul. 85-13, 1985-1 C.B. 184 and PLR 9535026.

[3] Department of the Treasury, Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts, General Explanation of the Administration’s Fiscal Year 2014 Revenue Proposals (April 2013), p. 145.


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DING Trusts

State income tax may be avoided if assets may be transferred into a non-grantor trust in such a way as to avoid the transferor making a gift. The typical acronym for such trusts is a DING Trust, for Delaware Incomplete Non-Grantor Trusts, but there is nothing magical about Delaware as the state in which the trust ought be created.

Typically, the grantor of the trust wants to be a beneficiary. Thus, in order to avoid grantor trust status the grantor may receive distributions only at the direction of adverse parties. Generally, some of the grantor’s descendants are beneficiaries of the trust and are thus thought to be adverse for income tax purposes, and thus are empowered to make distributions to the grantor.

The grantor also wants the transfer to be incomplete for gift tax purposes.   In a string of rulings beginning in 2001 the IRS determined that a testamentary power of appointment in the grantor made the gift incomplete. See e.g. 200148028, 200715005, and others in between.   In CCA 201208026 the IRS reversed that position, concluding that the testamentary power of appointment would only affect the remainder interest not the income or present interest. So, the trick is to give the grantor some power that will make the gift incomplete but that will not cause the trust to be a grantor trust for income tax purposes.

One such power is the grantor’s power to make distributions in a non-fiduciary capacity pursuant to a fixed and ascertainable standard under Reg. §2511-2 so long as retention of such power does not cause the assets of the trust to be subject to the grantor’s creditors because that would cause the trust to be a grantor trust for income tax purposes. Delaware does not protect trusts where a grantor has such a power but Ohio, Nevada and Wyoming do.

Another potential power would be to require the grantor’s consent before distributions were made to others. This power would pass muster in many of the asset protection states, including Delaware.

In IR-2007-127 (July 9, 2007) the IRS announced it was reconsidering its position on the gift tax consequences to the beneficiaries on the distribution committees. The IRS was likely spooked by comments from a professional group about the tax consequences of DINGs and the government’s arguably incoherent ruling position. However, without comment on what learning has been achieved, the IRS has begun issuing rulings in this area, on March 8, 2013 issuing PLRs 20131002 – 006. There the grantor had to give consent if a majority of the distribution committee wanted to make a distribution, but a unanimous committee could distribute regardless, and the grantor could distribute assets among the grantor’s issue for health, education, maintenance and support in a non-fiduciary the capacity. The IRS determined that the transfer was incomplete, the trust was not a grantor trust, the distribution of assets to the grantor was not a gift by the committee, and a direction by the committee to distribute to others is not a gift by the committee (although it would be by the grantor at that point). On the latter issue, the key structural issue would seem to be ensuring that the distribution committee members are adverse to one another. If a member is not replaced when failing or ceasing to serve, then the increasing control of surviving members appears to generate the necessary adversity.

Turney P. Berry
Louisville, Kentucky