As presented by Griffin Bridgers to the Santa Fe Estate Planning Council, April 20, 2022

1. Basis and Income Tax Planning
Through Retained Interests
Presented to the Santa Fe Estate Planning Council by:
Griffin H. Bridgers
Hutchins & Associates LLC
Denver, CO
gbridgers@hutchinslaw.com

2. How Far We’ve Come
• Currently, the estate tax basic exclusion amount is $12,060,000
• However, many estate plans were set up at a time when the exclusion
amount was much lower – for example, the exclusion was:
• $3,500,000 in 2009
• $675,000 in 2001
• $500,000 in 1986
• $120,000 in 1977
• I include these milestones to illustrate the tax reforms of 1977, the “new”
Internal Revenue Code in 1986, the Bush tax cuts under EGGTRA in 2001,
and sunset of EGGTRA at the close of 2009
• Note also the onset of the portability election in 2011, coupled with the
new permanent, inflation-adjusted basic exclusion amount of $5,000,000
(doubled to a base of $10,000,000 for 2017-2025 under the TCJA)

3. Psychology of Tax Planning
• While I am not a specialist in this area, I do think it is helpful to identify the
psychological and emotional limitations we impose upon clients
• In the context of today’s discussion, there are some common themes handed
down through generations of estate planners (both within and outside of their
firms):
• Avoid, at all costs, paying estate tax
• Avoid, at all costs, wasting estate and GST tax exclusions by applying them to the same assets
• These “rules” look at transfer taxes in a vacuum and ignore income taxes
• The question is whether you are willing to let go of some of these “sacred cows”
to better assess a client’s entire tax situation
• This presentation is designed to not only look at the mechanical and technical
elements of estate and income tax planning, but also some of the driving themes
behind these

4. Interplay with Income Tax
• Many practitioners recognize, but rarely acknowledge, the interplay
between income and estate/gift taxes
• Generally, the estate and gift taxes are designed to replace the income tax
on gifts/inheritances by shifting the burden of taxation from the transferee
to the transferor
• This works differently for income in respect of a decedent, but still carries a
deduction for estate tax attributable to IRD under IRC 691(c)
• To avoid double-tax, there is a basis increase mechanism which, in a perfect
world, would correlate to transfer tax actually paid
• This still applies for the gift and GST tax, but is eased for the estate tax
• The “ticket to entry” for a step-up in basis for property at death is inclusion
in the gross estate, according to IRC 1014(b)(9) (with a bonus for a
surviving spouse’s one-half of community property under IRC 1014(b)(6))

5. Basis
The 30,000 Foot View – Pre-Step-Up
Appreciation
Only the asset’s
net realized
appreciation in a
taxable sale or
exchange is
subject to income
tax
But, the
appreciation and
basis are subject
to gift, estate,
and/or GST tax at
the relevant
valuation date

6. Stepped-Up Basis
The 30,000 Foot View – Post-Step-Up
Key Lesson: Basis
usually only
matters for
income tax
purposes, but
payment of
gift/GST tax OR
inclusion in the
gross estate
increases basis
Note: The same
asset is never
subject to both
estate tax, and
income tax on
growth accruing
during the
decedent’s life

7. Something to Ponder
• It seems intuitive to step up the basis of appreciated assets using the estate
tax applicable exclusion (basic exclusion plus DSUE)
• BUT, could we be so bold as to propose the strategic payment of estate tax
to lower capital gains, especially since the same asset is never subject to
both estate tax and income tax on capital gains accruing during the
decedent’s life
• This only makes sense if there is positive arbitrage when you subtract the
estate tax rate from the capital gains rate, which there never is when you
compare the highest rate
• 25% minus 40% is not a positive arbitrage
• This is flawed thinking, however, when you look at effective rates – this can
create a positive arbitrage

8. Effective Tax Rate Comparison – An Example
• You can use the following formula for tax “equilibrium” assuming you can use a
25% flat state and federal capital gains rate, with “TE” being the taxable estate
which would generate such equilibrium:
(TE - 12,060,000) x 40% = (TE - decedent’s lifetime basis) x 25%
• Assuming zero basis, we can include up to $32,160,000 in the taxable estate
before the estate tax paid exceeds the capital gains saved
• Assuming a basis of $6,000,000, we can include up to $22,160,000 in the taxable
estate before the estate tax paid exceeds the capital gains saved
• Long story short, sometimes paying estate tax is worth it, especially as the basis
(pre-step up) approaches zero – but going the other way, once basis approaches
$19,296,000, you lose this advantage

9. Effective Rates – A Graph
Blue: Capital gains
effective rate
Green: Estate tax effective
rate
Scale: 1:10,000,000
$36,160,000 is our equilibrium point with zero basis and $12,060,000 exclusion

10. A Pause
• Before getting into the mechanics of a step-up in basis due to the
death of an owner (or deemed owner) of property, it is helpful to
review the basis rules applicable to gifts
• As we will see, there is only step-up potential on the rare occasion
that gift or GST tax is paid out of pocket

11. Gift Transfers and Basis
• Gifts typically follow a carry-over basis rule
• But, for gifts of loss property (basis is greater than fair market value), you
cannot gift the loss because the gift tax only applies to the fair market
value
• So, in that case, special rules apply to the donee as follows:
• If the donee sells the property for less than the FMV at the time of gift, the donee’s
loss is determined based on this FMV
• If the donee sells the property for more than the donor’s carryover basis, the donee
gets to use this basis to calculate gain (which can create income tax savings if you gift
loss property in a down market
• If the donee sells the property for an amount between the date-of-gift FMV and the
carryover basis, there is no gain or loss

12. Gift Tax and Basis
• Any gift tax and generation-skipping transfer tax actually paid out-of-
pocket increases the basis of the property generating the tax, but not
dollar-for-dollar
• This is where basis and gain actually matter. Why? Because the
portion of the transfer tax(es) attributable to gain (and not basis) is
what increases the basis
• But, you can only use the taxable value of the gift (minus annual
exclusion, marital deduction, and charitable deduction)
• So, you divide the potential gain by the taxable value of the gift, and
multiply by the transfer tax paid

13. Example
• Donor makes gift of stock worth $116,000, with a basis of $46,000.
Gift tax of $20,000 is paid out-of-pocket by the donor. What is the
donee’s basis?
• First, we need the built-in appreciation or gain, which is ($116,000 - $46,000)
= $70,000.
• Next, we need the taxable value of the gift net of the gift tax annual exclusion,
which is ($116,000 - $16,000) = $100,000.
• Then, we multiply this fraction ($70,000 / $100,000, or .7) times the gift tax of
$20,000, for a basis increase of $14,000.
• This is the portion of the gift tax on the taxable gift attributable to the gain and not the
basis
• Thus, the donee’s new basis is ($46,000 + $14,000) = $60,000.

14. Gift tax annual exclusions and deductions
Basis
The 30,000 Foot View – Gift Tax Step-Up
Appreciation
Gift tax applies to
appreciation and
basis, but not to
annual exclusions
and deductions
Only the portion
of gift tax
attributable to
appreciation can
generate a step-
up in basis

15. Ways to Get Step-Up in Basis
• Own property at death
• Surviving spouse’s one-half interest in community property also gets a step-up
• Have previously transferred property, but retain an interest at death described in
IRC Sections 2035-2038 (for gifted property), or Treas. Reg. 25.2511-2(c) (for
incomplete gifts)
• Be the beneficiary of property which, at your death, is subject to:
• A general power of appointment under IRC 2041, whether or not exercised
• A QTIP election made at the death of a predeceased spouse
• A special power of appointment which you exercise in a manner that triggers the Delaware
Tax Trap
• Distribute property out of a trust to a beneficiary before the beneficiary’s death
• This is subject to fiduciary duties, and creates the risk of over-inclusion in the gross estate (to
be discussed)

16. Property Not Benefitting From Basis Step-Up
• Income in respect of a decedent (IRD)
• Examples: annuities, retirement plan assets, some promissory notes
• Qualified small business stock (QSBS) to the extent of the first
$10,000,000 of gain on a potential sale
• You technically get the basis step-up but lose the benefit of the gain exclusion
• C corporation stock, if there is a sale of C corporation assets
• Depreciated property (fair market value as finally determined for
federal estate tax purposes is less than basis)

17. What About Income in Respect of a Decedent?
• Items of income in respect of a decedent (IRD) are not eligible for a
step-up in basis
• BUT, there is a deduction under IRC Section 691(c) for estate tax
attributable to IRD
• This is a miscellaneous income tax deduction that can be deducted by
the recipient of IRD in the year IRD is included in gross income
• This acts similar to a step-up in basis, but only applies to the extent
estate tax is actually paid out of pocket

18. Married Couples: Double Step-Up
• Gross estate inclusion is the technical requirement for a step-up in basis
• For married couples, this means that a step-up at both deaths requires inclusion
of the same asset in the gross estate twice
• This is a problem because it wastes exclusion – a cardinal rule is avoiding
application of estate tax exclusion to the same asset twice
• But, this is not the case if the marital deduction is claimed - we can look at a
double-step-up for married couples through the use of a marital trust
• Portion of marital trust included in survivor’s gross estate (either by outright
transfer to survivor, retention of a general power of appointment, or QTIP
election) gets a step-up in basis at death of both spouses
• Once upon a time, you could only make QTIP election to the extent necessary to zero out
estate tax, but post-portability you can now use QTIP election for entire taxable estate
• Portability election helps avoid wasting of exclusion in such a scenario as well,
and removes prior need to equalize estates

19. Overexposure
• Any time you start introducing assets to the gross estate, you run the
risk of overexposure
• As we saw above, the traditional definition of “overexposure” was
creation of any estate tax and/or GST tax liability, but some payment
of these taxes based on effective rates may not always be a bad thing
• Note also the sunset of the TCJA – what is not overexposed today may
be overexposed starting on January 1, 2026
• So, is there any way you can obtain microscopic control over this
overexposure risk? Yes, through the formula general power of
appointment

20. Formula General Powers of Appointment
• For many years now, thought leaders have been touting “formula” general powers of
appointment as a method to get a step-up in basis
• While these seemed OK for GST tax purposes, no IRS rulings specifically blessed them,
especially in the modification/decanting arena
• In PLR 202206008, however, the IRS ruled:
• A formula GPOA, created by a trust modification, does not shift a beneficial interest in a GST-
exempt trust to a lower generation beneficiary
• Only the portion of a trust subject to a formula GPOA (which is capped at the “largest amount”
that would not increase the holder’s transfer tax liability) would be included in the holder’s gross
estate at death
• Takeaway: while this is a PLR that is not binding authority, formula clauses should be OK,
even when added after the fact through modification/decanting
• Note, however, that the text of the PLR cited the grantor’s intent to “save transfer taxes” – having
a material purpose like this expressly stated in the trust helps
• Note also that this was a GST and estate tax ruling – not an income tax ruling – so the intent to
“save transfer taxes” may not contemplate income tax savings

21. Drafting Points – Formula GPOA
• Be careful about the effect of state inheritance and death taxes
• Some states have very low exemptions, so basing the formula off of zero “transfer taxes” at both
the state and federal level may under-include assets in a beneficiary’s gross estate and minimize
step-up opportunities
• This is the opposite of the overexposure problem above
• Consider cherry-picking assets, but note that this approach to a formula GPOA has not
been condoned by the IRS
• Omit IRC, QSBS stock, and loss property from base of assets to which formula GPOA may apply
• Use cascading inclusion on a tax-lot by tax-lot basis
• For example, consider potential income tax of each asset pre-step up, and apply step-up to trust assets in
descending order of assets’ potential income tax
• Remember that simply zeroing out estate tax may not maximize step-up opportunity –
there is a break-even point before which the estate tax paid does not exceed the income
tax saved
• So, instead of including an amount up to the holder’s unused estate tax/GST tax exclusion, consider
including an amount up to the point at which the additional estate, GST, and state
death/inheritance taxes equals the amount of income tax saved

22. Spousal Formula GPOA
• It may be possible to consider a spousal formula GPOA, but there are
some key points to keep in mind:
• No QTIP election can be made with respect to any portion of a marital trust
which is subject to a GPOA
• If a QTIP election was made, the property is already includable in the gross
estate of the surviving spouse
• If the formula GPOA applies to a credit shelter trust, it applies both spouse’s
exclusions to the same assets – this wastes exclusion
• Example: Spouse 1 died and funded credit shelter trust with $12,060,000. Spouse 2 dies
the next day, holding a formula GPOA over the credit shelter trust. Both spouse’s basic
exclusions applied to the same assets, meaning they could not effectively combine them
• This is the same result if, instead, large in-kind distributions of appreciated property are
made from the credit shelter trust to the spouse

23. Previously Gifted Assets and Formula GPOA
• The formula GPOA approach works well for a beneficiary who is not the
original grantor of the trust
• It seems tempting to explore pulling assets back into a grantor’s gross
estate, especially when the assets were gifted when the estate tax
exclusion was much lower
• However, this can be dangerous, for a few reasons:
• IRC Sections 2036 and/or 2038 will typically apply, and these supersede IRC Section
2041 (which deals with general powers of appointment)
• The formula approach under IRC Sections 2036 and 2038 may not work, or at least
may not work the same as under IRC Section 2041
• You run the risk, for example, that the IRS finds a “prearranged plan” to later add a formula
GPOA, thus applying 2036/2038 to ALL assets of the trust
• Even where the formula approach works, you may lose prior/current discounts and
waste some prior gift tax annual exclusions

24. Previously Gifted Assets and Loans/Exchanges
• For a grantor trust, it may be possible for the grantor to exchange high-
basis assets (outside of the trust) for low-basis assets (inside of the trust)
• Thus, at the grantor’s death, the low-basis assets will be eligible for a step-up in basis
• If the grantor does not have enough high-basis assets, or cash, for this to
make sense, can the trustee loan the assets to the grantor? Or, could the
grantor buy the assets back for a note (a reverse sale to IDGT)?
• Economic substance, and prearranged plan, arguments could come into play, even
when there is adequate security and where the grantor has sufficient assets to repay
the note at death
• Keep in mind the effect of the note at death – grantor trust status terminates and the
unpaid portion of the note becomes a taxable installment from the grantor’s estate
to the trust (possibly using the basis as it existed just prior to grantor’s death)
• End result – grantor’s estate may get a deduction for the note under IRC 2053, but there may
be a deemed exchange which creates a recognition event to the trust

25. Deathbed Swaps and Exchanges
• Timing is everything – in an ideal world you can get low basis assets
into a decedent’s hands right before death, but this rarely happens
• Deathbed swaps with grantor trusts may be your best bet
• Deathbed distributions from a trust with ascertainable distribution
standards would probably not pass muster, as one could argue that a
beneficiary on their deathbed has no “HEMS” needs
• But, if you have a fully discretionary trust, this gives you the best of
both worlds
• Query: Could a trustee’s fiduciary distribution power over a fully discretionary
trust be used to grant a nonfiduciary formula GPOA?

26. Offensive GPOA - Introduction
• When representing an estate that is not taxable, you could use the
IRS’s own arguments against them to argue for a GPOA
• Keep in mind that while a power of appointment for state law
purposes is a non-fiduciary power of appointment, tax law considers
both fiduciary and non-fiduciary powers in its definitions of powers of
appointment
• Using past IRS rulings, cases, and dicta, there are opportunities to
perhaps unwind gifts or find general powers of appointment where
they were not intended to claim a step-up in basis
• The problem is documenting it – the IRS does not require proof of a
step-up in basis when the estate is not required to file a 706

27. Offensive GPOA – Common Methods
• Here are some ways to explore claiming an offensive GPOA:
• Power to both remove and replace trustee, where replacement is the person
exercising the power or where replacement is someone related or
subordinate (according to IRC 672(c)) to the person exercising the power
• Reciprocal trusts - arguing that they exist (especially for spouses)
• Keep in mind that this is usually applied where spouses are beneficiaries of each other’s
mirror image trusts, but it could also apply where they are simply trustees of a trust
created by the other (see Estate of Bischoff, 69 T.C. 32 (1977))
• Lapsed general powers of appointment, where the former holder is still a
beneficiary of the trust
• This can apply in trusts, AND in durable powers of attorney
• Post-lapse or release, the former powerholder as beneficiary or trustee holds retained
interests described in IRC Sections 2036 and 2038

28. Step-Up in Basis At Death – Other Tools
• You could also consider the following arguments, depending on the
state(s) involved:
• Surviving partner claiming a common-law marriage – thus allowing free step-
up in basis for transfers to that surviving partner
• Gift was incomplete (see Estate of Powell)
• Looking through a family partnership or entity to claim asset inclusion in
excess of retained entity interest (again, see Estate of Powell)
• Exercise of limited power of appointment to trigger Delaware tax trap
• In essence, this means that exercise of power extends perpetuities period which applied
to prior trust
• Note that in many states, this is now much more difficult to do – it may require that you
give a beneficiary a presently-exercisable general power of appointment, also known as a
PEG power

29. Problematic Assets
• Note that for entity interests, a step-up in outside basis for the equity interest of a deceased
owner may not be shifted to the inside basis of assets owned by the entity
• For partnerships, this is possible if an IRC Section 754 election is made with respect to the
deceased owner’s interest
• For S corporations, this is only possible if the S corporation is liquidated in the same year of the
step-up, and even then it creates gain for the living shareholders
• For C corporations, due to the General Utilities doctrine (see IRC 312), basis in stock generally
cannot be used to reduce gain on corporate sale or deemed sale of appreciated corporate assets
• You could convert to an S corp, but there is a built-in gains tax that prevents circumventing this potential gain
for 5 years post-conversion, and all pre-conversion accumulated C corp earnings are still subject to tax on
dividends
• Related party rules typically prevent the use of stepped-up basis through redemptions, spin-offs, or type “D”
reorganizations
• You must consider attribution rules before and after transaction under IRC Section 318
• Note that redemption not in liquidation could be constructive dividend, having the opposite effect – taxing entire stepped-up
basis as dividend

30. QUESTIONS?
• Send questions and topic suggestions to gbridgers@hutchinslaw.com
• To connect with me further:
• griffinbridgers.substack.com (for my newsletter)
• YouTube: Griffin Bridgers (280+ topical videos)
• THANK YOU!