IRS Revenue Ruling 2023-2

 https://www.reuters.com/legal/transactional/irs-confirms-that-completed-gifts-grantor-trusts-are-not-eligible-section-1014-2023-06-21/

An irrevocable "grantor trust" is an anomaly under the Code. A "grantor trust" is not recognized as a separate taxpayer for income tax purposes during the lifetime of the creator (commonly referred to as the "grantor" or the "settlor"). All income earned during the grantor's lifetime is reported on the grantor's individual income tax returns. Yet, if the grantor trust is irrevocable, and if the transfers to the trust are deemed to be completed gifts, then upon the death of the grantor, the assets of the grantor trust are not included in the taxable estate of the grantor for estate tax purposes. So, a grantor trust is deemed to be owned by a grantor for income tax purposes, but not for estate tax purposes: thus, the uncertainty over the eligibility of the grantor trust assets for the Code Section 1014 basis step-up on the death of the grantor.

The uses of "intentionally defective" grantor trusts for estate planning purposes are prolific. Because the grantor is treated as the owner of the grantor trust for income tax purposes, she is responsible for the payment of the income taxes incurred by the trust. The payment by the grantor of the grantor trust's income taxes effectively allows the grantor to make additional tax-free gifts to the grantor trust and increases the grantor trust's rate of return. This can be a very powerful technique.

Sales and exchanges between the grantor and the grantor trust are also ignored for income tax purposes. Accordingly, it is very common for a grantor trust to purchase a business interest and/or other appreciating property from the grantor. Oftentimes, the purchase price is paid by making a 9-year interest only promissory note payable to the grantor (the "Sale Technique").

Since the grantor trust is not a separate taxpayer for income tax purposes, there is no recognition of gain on the sale, nor of interest income on the note. The interest rate on the note can be the lowest rate which will not cause adverse tax consequences. (This rate changes monthly and is currently 3.56% for June 2023.) If the interest sold to the grantor trust grows faster than the applicable interest rate, then the excess growth passes transfer-tax free to the grantor trust.