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Priority Guidance Plan

Some folks eagerly await the release of a new album. Others camp outside of big box retailers to get the jump on holiday gifts. There are those who line up at box offices to purchase tickets for a concert that is months away. Then there are some who might as well be sitting on pins and needles after they’ve learned that their favorite tech company is about to announce the arrival of their latest “must-have”[i] gadget.

Tax folks are generally more grounded and less impressionable than most other folks. They reserve their excitement for news that may actually be impactful; for example, the Treasury’s release last Friday of its 2022-2023 Priority Guidance Plan, which identifies and prioritizes those tax issues that the Treasury and the IRS have determined are most important to taxpayers and tax administration and that should be addressed through regulations, revenue rulings, revenue procedures, notices, and other published administrative guidance.[ii]

That is not to say that tax advisers agree with every item in the Plan. In fact, there are a few items that raise substantive questions, others that seek to legislate using Treasury’s regulatory authority, and a couple that do both.

Basis Step-Up

Included within the last group is the second guidance project listed under the general heading of “Gifts and Estates and Trusts”:

“Guidance regarding availability of §1014 basis adjustment at the death of the owner of a grantor trust described in §671 when the trust assets are not included in the owner’s gross estate for estate tax purposes.”

Sounds familiar? It should. It’s targeted at sales to grantor trusts.[iii]

Care to guess the direction in which this regulation project is heading? Actually, I probably shouldn’t have used the word “guess” or even asked the question.

Before addressing what is probably obvious to most, and to give it some context, let’s review some of the history related to this regulation project.

In the Beginning

When the Obama Administration released its 2014 budget proposal, it included a provision under which the property sold by a grantor to a grantor trust would have been included in the grantor’s gross estate for purposes of the federal estate tax.[iv]

As you may recall, the then Republican-controlled Congress ensured the demise of this proposal.

Priority Guidance Plan

However, as the old maxim goes, “if you can’t legislate, regulate.” Thus, at the beginning of 2015, the IRS added the following item to its list of matters on which it would not issue letter rulings:[v]

“Section 1014. Basis of Property Acquired from a Decedent. 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.”

Shortly thereafter, the Treasury added the same item to its Priority Guidance Plan,[vi] and it has been included in the Plan ever since (except for the 2021-2022 Plan), though the project description was shortened as follows: “Guidance on basis of grantor trust assets at death under §1014.”

Typically, matters that appear on the no-ruling list reflect are areas of the tax law that are under study at the IRS, and that the IRS hopes to address through the publication of a revenue ruling, a revenue procedure, regulations, or otherwise.

Although many found this addition to the no-ruling list disturbing, others welcomed the development insofar as it promised the resolution of a tax issue that accompanies a still commonly used estate planning technique for the transfer of interests in a closely held business: the sale to an “intentionally defective”[vii] grantor trust.

Budget Proposal

The fact that the Treasury and the IRS were examining the application of the basis step-up rules to certain property held in what had been a grantor trust did not dissuade the Obama Administration from again proposing a legislative solution as part of its final budget proposal, for the fiscal year ending September 30, 2017.

The Green Book for that year[viii] explained that the sale to a grantor trust is used for transferring wealth while minimizing the gift and income tax cost of the transfer. According to the report, the greater the post-transaction appreciation, the greater the transfer tax benefit achieved. Even the future capital gains tax can be avoided, the report continued, by the grantor’s purchase at fair market value of the appreciated asset from the trust and the subsequent inclusion of that asset in the grantor’s gross estate at death. The basis in that asset would be adjusted (“stepped up”) to its fair market value at the time of the grantor’s death, often at an estate tax cost that has been significantly reduced or eliminated by the grantor’s exclusion from estate tax.[ix]

Build Back Better

Then came the Biden Administration’s Build Back Better legislative proposal in 2021.[x] Following the President’s introduction of his proposal to a Joint Session of Congress in late April of 2021, in which he made no mention of the grantor trust rules, the Treasury released the Green Book for the Fiscal Year 2022 Budget, which proposed that transfers of property into a trust, and distributions in kind from a trust, other than a grantor trust that was revocable by the donor, would be treated as gain recognition events for purposes of the income tax.

The deemed owner of a revocable grantor trust would have recognized gain on the unrealized appreciation in any asset distributed from the trust to any person other than the deemed owner or the U.S. spouse of the deemed owner. All the unrealized appreciation on assets of a revocable grantor trust would have been realized at the deemed owner’s death or at any other time when the trust became irrevocable.

Ways and Means

Then came the House Ways and Means version of the Biden plan, which basically sought to resuscitate the Obama Administration’s budget proposal, and also sought to restrict the sale of property to grantor trusts.[xi] Specifically, under the Committee’s proposal, upon the grantor’s death their gross estate would have included the assets the grantor was treated as owning under the grantor trust rules at the time of their death.[xii] In determining whether the transfer of property between an irrevocable grantor trust and the deemed owner of the trust constitutes a sale for purposes of the income tax, the grantor’s status as the deemed owner would have been disregarded. The grantor would have been treated as having sold the property for income tax purposes – the grantor would have had to recognize the gain realized.

Then, in late October 2021, the President announced that there had been a change in plans. That same day, the House Rules Committee introduced a much-revised version of the bill, which no longer sought to limit the use of grantor trusts.[xiii]

Of course, the President’s plans for amending the Code did not go far[xiv] but they have not been discarded, nor should tax advisers forget them just yet.


Following the Build Back Better fiasco, it appears the Treasury has picked up on the “can’t legislate, then regulate” maxim, as reflected in the Treasury’s most recent Priority Guidance Plan, which harkens back to the 2014-2015 Obama Administration’s Priority Guidance Plan and leaves little doubt as to its intended target.

Before addressing the Plan, let’s take a moment to consider this target; i.e., the sale of appreciating property – like the sale of an equity interest in a closely held business – to a so-called “intentionally defective grantor trust” or “IDGT.”

Sale to Grantor Trust

A taxpayer using this estate/gift tax vehicle would first create an irrevocable trust structured as a grantor trust so that the grantor[xv] is treated as the owner of the trust for income tax purposes.[xvi] The grantor would then make a “seed” gift to the trust, typically of an amount equal to at least 10 percent of the fair market value of the business interest to be “sold” to the trust.[xvii] The still-enhanced gift tax exemption[xviii] allows a larger seed gift to be made on a tax-free basis, which allows more property to be sold to the trust.

The grantor then sells business interests to the trust[xix] in exchange for a note with a face amount equal to the value of such interests,[xx] bearing interest at the applicable federal rate[xxi] and perhaps secured by the property acquired.[xxii] The interest should be payable at least annually,[xxiii] with a balloon payment at the end of the note term.

The “sale” to the grantor trust is not subject to capital gains tax because the grantor cannot sell or otherwise transfer property to themselves.[xxiv] When the grantor became the owner of the trust at its inception, they became the owner of the trust property for federal income tax purposes. Accordingly, the transfer of property from the grantor to the trust was not a sale[xxv] for federal income tax purposes – it wasn’t even a transfer – and the grantor did not acquire a cost basis[xxvi] in that property.

The Issue, Generally

Sales to grantor trusts take advantage of the inconsistency between the income tax and transfer tax rules – specifically, the ability to sell a property for gift tax purposes, but to still own it for income tax purposes – in order to transfer wealth while minimizing the gift and income tax cost of such transfers.

If this wasn’t bad enough for the IRS, future capital gains taxes may also be avoided by the grantor’s “repurchase,” at fair market value, of the appreciated asset from the grantor trust and the subsequent inclusion of that asset in the grantor’s gross estate at death. Under current law, the basis in that asset is then adjusted (“stepped-up”) to its fair market value at the time of the grantor’s death, often at an estate tax cost that has been significantly reduced or entirely eliminated by the grantor’s lifetime exclusion from estate tax.[xxvii]

If successful, the value of the business interest sold to the trust is frozen in the grantor’s hands in the face amount of the note for purposes of the estate and gift taxes. Thus, if the note is satisfied while the grantor is still alive the grantor will receive property with a value equal to the date-of-transfer value of the business interest transferred to the trust. The remaining trust corpus[xxviii] – i.e., the hopefully appreciated value of the business interest – passes to the beneficiaries of the trust.[xxix]

Query, however, what the consequences would be if, before the satisfaction of the note, the grantor released the rights that caused the trust to be treated as a grantor trust. Would there be a sale at that time in which the grantor would be treated as having transferred property with a fair market value equal to the unpaid balance of the note issued by the trust?

Yep. The IRS has previously issued revenue rulings in which it held that the grantor of a grantor trust would be treated as having transferred property to the trust, and as having received consideration from the trust, at the time the grantor ceased to be treated as the owner of the trust.[xxx]

Death of the Grantor

Which brings us to the recently released Priority Guidance Plan and what will likely be the IRS’s treatment of the basis of the trust’s property following the death of the grantor while the note remains outstanding.

The Note

If the grantor dies before the note is satisfied, the value of the note as of the date of death will be included in the grantor’s gross estate for estate tax purposes.[xxxi] Thus, the fair market value of the note at that time, plus the accrued but unpaid interest thereon, would be subject to estate tax.

Moreover, assuming gain is realized on the transfer, the note will represent an item of “income in respect of a decedent”;[xxxii] thus, the note would not receive a basis step-up (unlike most items of property that are included in a decedent’s gross estate), thus preserving the tax gain inherent in the note.[xxxiii]

The Trust’s Property

So long as the grantor retains those rights or powers with respect to the trust property that caused the trust to be treated as a grantor trust for purposes of the income tax (for example, the right to substitute property of equal value[xxxiv]), the grantor will be treated as owning the trust’s assets, and any transfer of property between the grantor and the trust, whether or not in exchange for any consideration, will be disregarded for purposes of the income tax.[xxxv]

As indicated above, if a grantor were to release these rights or powers, and the trust thereby ceased to be treated as a grantor trust, any “transfers” of property previously made by the grantor to the trust will become effective for purposes of the income tax. Where such a transfer was made in exchange for a promissory note, and such note remained outstanding at the time of the release, a sale will occur and gain may be realized at that time.[xxxvi]

Grantor’s Death

What if the “release” of the grantor’s rights or powers occurs as a result of the death of the grantor? It is clear, from an income tax perspective, that the trust ceases to be a grantor trust and that the transfer to the trust is completed at the death of the grantor. The question of gain recognition, however, has not been resolved.

The basis of property in the hands of a person acquiring the property from a decedent, or to whom the property passed from a decedent, is the fair market value of the property on the date of the decedent’s death.[xxxvii]

Property that is acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent, is considered to have been acquired from the decedent,[xxxviii] as is property acquired from the decedent by reason of death, form of ownership, or other conditions, if by reason thereof the property is required to be included in determining the value of the decedent’s gross estate.[xxxix]

Can it be said that the property transfer that results from the termination of grantor trust status upon the death of the grantor occurs subsequent to the acquisition of such property by the grantor-decedent’s estate from the grantor-decedent?

The answer has to be yes. Until the death of the grantor, the grantor still owns the property for purposes of the income tax. Their death is the event that ends the grantor’s ownership and from which springs the transfer in exchange for the trust’s note.


Many commentators point to the foregoing as support for the position that this property should receive a step-up in basis to its then fair market value, which will likely be greater than the original face amount of the note if the asset has appreciated in value. Does that mean there will be a bargain sale following the death? How should the bargain element be treated for tax purposes?[xl]

Upon the immediately subsequent sale of the assets to the trust, this step-up would offset the consideration received (i.e., the note) and eliminate any gain.

The IRS, on the other hand, has stated that because the property was transferred to a trust prior to the death of the grantor, the basis step-up rule should not apply unless the property was included in the grantor’s gross estate for purposes of the estate tax. Because the property held by the trust is not included in the grantor-decedent’s gross estate, it should not receive a basis step-up. Thus, gain would be realized on the sale that is deemed to occur immediately after the grantor’s death – in other words, the grantor’s estate is the seller and it would recognize gain as payments are made on the note.[xli]

The IRS’s position is consistent with the situations described in the basis step-up rules in which the property that is treated as being acquired from the decedent was also included in the decedent’s gross estate.[xlii]

It is also consistent with the legislative proposals described earlier that sought to “remedy” the inconsistency or lack of coordination between the income tax and estate and gift tax rules applicable to a grantor trust.

Parting Thoughts

As I write this post, the results of the mid-term elections remain uncertain, though the pundits tell us that the Dems will lose their control of the House. As for the Senate, it’s still a toss-up. In fact, it appears the contest in Georgia is heading for a run-off in December. (Not again!)

Assuming a split Congress, the IRS will probably seek to address sales to IDGTs under its regulatory authority, as indicated in the Priority Guidance Plan.

However, query whether the IRS’s authority extends so far as to treat the grantor’s death as a tax-generating sale of property by their estate? Talk about breaking new ground.[xliv] Such a change is best left for Congress.

Even if this action was within the IRS’s authority, query whether it should be exercised to achieve the gain recognition that it seeks, especially following the uncertainty on this matter displayed by the Administration’s own party during the legislative negotiations last year?

Stay tuned.

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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] And overpriced.


I appreciate that some of you may secretly share my excitement and all, but I have to tell you that not every item included in the Plan warrants a positive reaction.

[iii] We’ll return to this shortly.

[iv] In addition, such property would have been subject to federal gift tax during the grantor’s lifetime if the grantor ever released the rights or powers that caused him to be treated as the owner of the trust’s property and income for purposes of the federal income tax. What’s more, the gift tax would have applied if the property were distributed from the trust

[v] Revenue Procedure 2015-3.

[vi] For 2014-2015.

[vii] When would one describe grantor trust status as “defective”? When such status wasn’t intended. This raises the question: in the process of ensuring that a trust implements a taxpayer’s dispositive plan for their assets, is the adviser also paying attention to the resulting income tax consequences? They should be – the economic effect may be significant.

[viii] .

[ix] The authors of the report would likely have stated that the “enhanced” exemption that has been in effect since 2018 (but which is scheduled to expire after 2025) has exacerbated the problem. This exemption (under IRC Sec. 2010 and Sec. 2505) was recently adjusted to $12.92 million beginning in 2023.

[x] Following a hiatus during the Trump Administration.


[xii] Any distribution (other than to the grantor or their spouse) from that portion of the trust deemed to be owned by the grantor would be treated as a taxable gift. If the grantor ceased to be treated as the owner of the trust during their lifetime, the grantor would be treated as having made a gift of the trust assets that the grantor was previously treated as owning.


[xiv] Thanks in no small part to Senators Manchin and Sinema, neither of whom smells like roses at present.

[xv] For purposes of the grantor trust rules, the “grantor” is the individual who created and funded the trust. Reg. Sec. 1.671-2(e).

[xvi] IRC Sec. 671. There are several rights that the grantor may retain or powers they may grant to another that would cause the trust to be treated as a grantor trust but would not cause the inclusion of the trust property in the grantor’s gross estate for purposes of the estate tax. For example, the grantor may retain the right, exercisable in a nonfiduciary capacity, without the approval or consent of any fiduciary, to reacquire the trust corpus by substituting other property of equivalent value. IRC Sec. 675(4).

[xvii] A smaller seed gift may be possible if the beneficiaries of the trust were to guarantee the note and had the wherewithal to satisfy such guarantee.

[xviii] $12.06 million this year; $12.92 million in 2023. IRC Sec. 2505.

[xix] Of course, this assumes that such transfers by the owners of the business are not restricted by a shareholders’, partnership, or operating agreement.

[xx] The issuance of a properly drafted note prevents a taxable gift because there is “adequate and full consideration” for the transfer. IRC Sec. 2512(b).

[xxi] IRC Sec. 1274.

[xxii] Notwithstanding any collateral, the debt should be recourse to the entire trust.

[xxiii] To avoid a deemed contribution to the trust for purposes of the gift tax under IRC Sec. 7872 and, more importantly, to support the treatment of the note as evidence of genuine indebtedness.

The payment and receipt of interest has no immediate income tax consequences.

[xxiv] Rev. Rul. 85-13.

[xxv] IRC Sec. 1001.

[xxvi] IRC Sec. 1012.

[xxvii] In a different context (QPRTs), the IRS has by regulation prohibited such swapping in order to defeat the step-up. See Reg. Sec. 25.2702-5(b)(1).

[xxviii] Plus any accumulated income.

[xxix] However, if the IRS were to successfully challenge the adequacy of the consideration, the difference between the value of the property and the face amount of the note would be treated as a gift, which may or may not be protected by the grantor’s remaining exemption amount.

[xxx] Rev. Rul. 77-402; Reg. Sec. 1.1001-2(c), Ex. 5; Rev. Rul. 87-61.

[xxxi] IRC Sec. 2031 and Sec. 2033.

[xxxii] IRC Sec. 691.

[xxxiii] IRC Sec. 1014(c).

[xxxiv] IRC Sec. 675(4).

[xxxv] Rev. Rul. 85-13; though it could have estate or gift tax consequences.

[xxxvi] Equal to the excess of the fair market value of the property and the grantor’s adjusted basis in the property.

[xxxvii] IRC Sec. 1014(a).

[xxxviii] IRC Sec. 1014(b)(1).

[xxxix] IRC Sec. 1014(b)(9).

[xl] As a testamentary transfer described in IRC Sec. 102(a)? Query whether the excess may be addressed by a formula adjustment clause based upon the value of the property as finally determined for estate tax purposes?

[xli] Under the installment method of IRC Sec. 453.

[xlii] IRC Sec. 1014(b)(1) and (9).

[xliv] And I’m not talking about burial plots.