Recent legislative developments, including the One Big Beautiful Bill Act (OBBBA) and the resulting expansion of the federal lifetime gift and estate tax exemption, have created a significant planning window for high‑net‑worth individuals to deploy exemption, either for themselves or strategically across generations. This environment presents particular opportunities where families wish to optimize basis outcomes in addition to transfer‑tax efficiency.
In some families, the younger generation may accumulate substantially more wealth than the older generation. In these circumstances, traditional estate planning that focuses exclusively on transferring wealth downward may be inefficient. A more effective strategy may involve shifting future appreciation into the senior generation’s estate in order to utilize that individual’s unused lifetime exemption and, critically, to obtain a basis step‑up under Internal Revenue Code (the
“Code”) §1014 at death.
The core objective of this strategy is to intentionally cause estate inclusion under §2041 of the Code without first triggering a completed gift under §2511 of the Code. This can be achieved by combining an incomplete gift trust with a testamentary general power of appointment held by the senior generation. Properly structured, this approach allows appreciation to be included in the senior generation’s taxable estate, thereby consuming available exemption and securing a basis adjustment, without incurring gift tax at the time of funding.
This strategy is particularly effective where the older individual has substantial unused exemption, relatively modest personal assets, or where capacity or practical considerations make outright ownership undesirable. In the current legislative environment, the expanded lifetime exemption under the OBBBA provides a meaningful opportunity to intentionally deploy exemption and optimize basis outcomes, allowing families to realign wealth and appreciation across generations in a manner that is both transfer‑tax efficient and income‑tax sensitive, without relying on speculative future legislative changes.
Structure of the Transaction
The first step involves a transfer of appreciating assets by the younger generation (G2) to an irrevocable trust that is intentionally drafted so that the transfer is incomplete for gift tax purposes. Under Treasury Regulation §25.2511-2(b) and (c), a transfer is incomplete if the transferor retains sufficient dominion and control to affect the ultimate beneficial enjoyment of the property.
This standard requires more than mere administrative control or powers that only create grantor trust status. Instead, the transferor must retain meaningful rights that allow changes to beneficial interests. These may include:
- A power to direct or veto distributions
- A power to alter or modify beneficial interests.
Not all powers that cause grantor trust treatment will render a transfer incomplete for gift tax purposes. The retained powers must be substantive and must directly affect beneficial enjoyment within the meaning of Treasury Regulation §25.2511-2.
When properly structured, the transfer is treated as incomplete, with the result that no completed gift occurs and the younger generation does not use any portion of its lifetime exemption. However, these retained powers must be preserved; a later release or lapse may result in a completed gift at that time.
After the trust is funded, the instrument grants the older generation (G1) a general power of appointment exercisable at death. Under §2041(a)(2) of the Code, property subject to such a power is included in the powerholder’s gross estate. Section 2041(b)(1) of the Code defines a “general” power as one that is exercisable in favor of the powerholder, the powerholder’s estate, or the creditors of either.
To ensure estate inclusion, the trust must permit appointment in favor of the powerholder’s estate or its creditors. Any limitation that restricts the power to a defined class of beneficiaries or subjects it to an ascertainable standard would convert the power into a limited power of appointment and prevent inclusion under §2041 of the Code.
Exercise of the Power and Incapacity Considerations
The ability to exercise the power becomes a critical issue if the older generation lacks testamentary capacity. A testamentary power of appointment is typically exercised through a will. However, some jurisdictions permit the governing instrument to allow exercise during life by written instrument, and in certain cases, an agent acting under a valid power of attorney may exercise a power of appointment if the power of attorney expressly authorizes it.
State law in this area varies significantly. Some jurisdictions do not permit an agent to exercise a power that is purely testamentary in nature. If the power is not validly exercisable under applicable law, the Internal Revenue Service (the “IRS”) could take the position that the power was not effectively held at death, potentially undermining estate inclusion under §2041 of the Code and, in turn, the availability of a basis step-up under §1014 of the Code.
For this reason, best practice is to draft the power so that it may be exercised “by will or by written instrument delivered during life,” and to ensure that any power of attorney includes explicit authority to exercise powers of appointment, to the extent permitted under state law.
Tax Consequences
Because the transfer to the trust is incomplete under Treasury Regulation §25.2511-2, the younger generation retains sufficient dominion and control such that no taxable gift is made at the time of funding. However, if the retained powers are subsequently released, lapse, or otherwise cease to exist, the transfer may become complete at that later time.
If the older generation holds a valid general power of appointment at death, the trust assets are included in the powerholder’s gross estate under §2041(a)(2) of the Code, regardless of the identity of the original transferor. Actual exercise of the power is not required; the existence of the power at death is sufficient, provided it is not subject to a condition that prevents its exercise.
As a result of estate inclusion, the assets receive a basis step-up to fair market value at death under §1014(a) of the Code. This adjustment can be particularly valuable for low-basis or highly appreciated assets, especially where a sale is anticipated shortly after death.
The IRS may scrutinize whether the estate inclusion is substantively respected and whether the arrangement has economic substance beyond its tax benefits, particularly where the senior generation lacks meaningful independent control. Accordingly, careful administration and contemporaneous documentation are important.
If the older generation has sufficient remaining estate tax exemption to cover the value of the included assets, no estate tax will be due. This effectively allows the family to shift significant appreciation into the senior generation’s estate without transfer tax cost while obtaining a full basis step-up.
Strategic Rationale
This planning technique is most effective where:
- The younger generation owns rapidly appreciating, low-basis assets
- The older generation has substantial unused estate tax exemption
- The older generation’s estate is otherwise below the exemption threshold.
The structure allows appreciation to be incorporated into the senior generation’s taxable estate to achieve a basis step-up, without requiring the younger generation to use its exemption or incur a completed gift.
Key Risks and Considerations
Despite its advantages, the structure presents several important considerations:
- Creditor Exposure: A general power of appointment may expose the trust assets to the powerholder’s creditors under applicable state law.
- Incomplete Gift Integrity: The retained powers must be sufficient to support incomplete gift treatment and must remain in effect.
- State Law Limitations: The ability of an agent to exercise a power of appointment depends on state law and the specific language of the power of attorney.
- IRS Scrutiny: The IRS may examine whether the structure reflects genuine estate inclusion or is merely a formal arrangement lacking substantive effect.
Key Technical Requirements
The integrity of the incomplete gift structure must be maintained under Treasury Regulation §25.2511-2. The general power of appointment must clearly satisfy the requirements of §2041(b) of the Code, without any limitations that would undermine its classification as a general power.
State law governing powers of appointment and agency authority must be carefully analyzed, particularly where incapacity is a concern. At death, inclusion should be properly reported on IRS Form 706, and valuation support should be maintained to substantiate the basis adjustment under §1014 of the Code.
Conclusion
An incomplete gift trust combined with a general power of appointment can be an effective technique for leveraging a senior generation’s unused estate tax exemption to obtain a basis step-up under §1014 of the Code without triggering a taxable gift by a wealthier younger generation.
Although the structure can produce significant income tax savings, particularly for closely held business interests with substantial built-in gain, it is highly dependent on careful drafting and proper administration. When implemented correctly, it offers a sophisticated method for repositioning appreciation within a family in a tax-efficient manner.
With expanded federal exemption levels creating unique opportunities, now is the time to assess whether an incomplete gift and general power structure could enhance both transfer tax efficiency and basis outcomes for your family. Contact Sebastian Pascu, Chair of KJK’s Estate, Wealth & Succession Planning Practice, at scp@kjk.com or 216.736.7294.