Why you should not create an Irrevocable Trust and the stepped up basis

Why you should not create an Irrevocable Trust and the stepped up basis

Historically, both NY estate lawyers and financial advisors alike convinced New Yorkers to forego traditional estate planning like creating a Last Will & Testament in favor of more elaborate, unconventional instruments, primarily Irrevocable Trusts.  Simply put, an Irrevocable Trust is similar to an LLC in that it removes the assets from your NY estate by taking them out of your name and depositing the asset into the trust.  The benefit of creating the Irrevocable Trust is that whatever assets you place in the trust are no longer subject to NY and Federal Estate Tax when we pass.  What these financial professionals and NY estate lawyers fail to tell their clients is that 99% of individuals do not have assets in their NY Estates that are subject to the Federal Estate Tax.  Pursuant to the Estate Law, the current unified credit, the amount of money that can pass tax free at the federal level is $13.6 million per individual and $27.22 million for married couples.  As such there are very few New York Estate plans that require such complicated, not to mention expensive, NY estate planning.  Therefore in most instances a simple NY will prepared by your NY estate lawyer should suffice.

Additionally, trust formation is exponentially more expensive to execute than a simple will and changing and/or revising the terms of said trust can be expensive and downright impossible.  Worse still are the affects an Irrevocable Trust can have on your NY estate down the road, namely the loss of your stepped up basis.

However flawed the peddling of Irrevocable Trusts were in the past, this NY estate strategy was recently exacerbated further by the IRS ruling 2023-2.  According to this recent IRS ruling, NY estate assets placed in an Irrevocable Trust where the grantor completed the gift of the asset into the trust are not eligible to receive a “stepped up basis” as they are assets not included in the decedent’s gross estate as defined by 1014(b).

To fully understand the implications of this IRS ruling we must take a step back and examine what the stepped up basis even is and what it means for your NY estate plan.  The stepped up basis may be the single most important part of your NY estate as it washes away any and all appreciation you have in your assets at the time of your death.  While, the stepped up basis does not affect your NY estate tax liability it does zero out any and all capital gains tax liability your heirs may have on said appreciation.

For example, If you bought your house in New York City prior to 1980 for $100,000.00 and you recently passed, there is a good chance that house would be worth in excess of $1 million today.  In which case you would have acquired $900,000.00 in appreciation over the course of your ownership.  This $900,000.00 appreciation would ordinarily be subject to the capital gains tax of 20% but for the “stepped up basis”.   When we die, our heirs receive the benefit of the stepped up basis on any and all assets passing through our NY estates valuing the acquisition of the NY estate asset on the date of death rather than the date the property was actually purchased.  In this scenario our property’s capital gains liability without the stepped up basis would be $180,000.00 while the liability with it is $0.00.  As such the stepped up basis enhanced the heirs’ inheritance by $180,000.00 by reducing their tax liability on the asset.

This recent IRS ruling only reaffirms our commitment to beginning each of our client’s NY estate plans with a simple NY will.  A simple NY will drafted and supervised by your NY estate lawyer is often the only NY estate planning tool required.   Once a NY will is prepared and executed the NY will will be eventually offered for probate when you are gone.  Any and all assets of a NY estate passing through probate benefit from the stepped up basis, thereby wiping away any and all of the substantial capital gains tax on appreciation of assets we acquire throughout out lifetimes.

If you or a loved one are thinking about planning your NY estate and would like to speak with a New York estate lawyer feel free to call The Law Offices of Jason W. Stern & Associates at (718) 261-2444 for a free consultation. Our NY estate lawyers have nearly 70 years of combined NY estate law experience drafting and probating the wills for families like yours in the counties of Queens, New York, Kings, Bronx, Westchester, Richmond, Rockland, Nassau, Orange, and Dutchess.