Perhaps one of the most amusing phrases used in the estate planning world is the term “Crummey Trust.” When the term is first heard, most respond with a smile or a perplexed look. Why would I want a Crummey Trust? The answer is you might want such a trust for the same reasons that Mr. and Mrs. Crummey wanted a trust in the 1960s.
Actually, there is no such thing as a Crummey Trust. Many trusts, however, contain specific language known as “Crummey Powers” which have evolved from the case of Crummey v. Commissioner, which was a Tax Court case from the late 60s which established a procedure allowing gifts to trusts to qualify for gift tax exclusions.
Gift Tax Rules
The federal gift tax law currently allows unlimited gifts between citizen spouses. Gifts to others are generally limited to $12,000 per donee per year. This is referred to as the annual exclusion. A gift tax is imposed on gifts over $12,000 per donee per year. The first $12,000 is gift tax free. To qualify for this annual exclusion, the gift must be something that the donee can have immediate access to and use such as cash, stock, an automobile, or a home. This immediate access is referred to as a “present interest.” If a gift is made for the benefit of a person “in trust,” the gift often does not qualify as a “present interest” because the trust provides that the beneficiary will receive specific distributions from the trust over time rather than having the present and immediate right to the trust assets.
Even if no tax is due, it is suggested that gift tax returns be filed each year to record the gift and make necessary tax elections.
Crummey vs. the IRS
In the late 1960s, Mr. and Mrs. Crummey tried to get around the present interest gift tax limitations. They created a trust for the benefit of their children, but with a new idea. The trust provided that the beneficiaries would be given notice of any gift to the trust and the beneficiaries would then have a limited right to withdraw the gifted assets for a specific number of days. If the beneficiaries did not exercise their rights of withdrawal within the time allotted (which they most certainly would not, for to do so would result in the wrath of Mr. and Mrs. Crummey who would make no further gifts to the trust), gifted assets would thereafter be locked in the trust. Mr. and Mrs. Crummey took the position that these gifts were a “present interest” because each beneficiary had a present right to withdraw the funds for a limited period of time. The annual gift tax exclusions for the gifts to the trust would be available. No gift tax would be due. The IRS did not like this idea and challenged the Crummeys. Fortunately for us, the IRS lost hands down.
The Crummey decision has evolved over the last 40 years. There have been court decisions too numerous to count refining the Crummey rules. The IRS has issued dozens of Rulings. What we have today is a series of rules, some of which are not necessarily clear, which give us basic guidelines to qualify gifts to a trust for the annual present interest exclusion and avoid gift tax.
Crummey Provisions
Crummey Trusts, if you wish to call a trust that, are simply trusts that contain the following provisions:
The Grantor makes a gift of money or property to the Trustee of a trust for the benefit of the trust beneficiaries.
The Trustee gives notice, generally in writing, to the beneficiaries of the trust. While written notice is not technically required by the IRS, it is the surest method to prove to the IRS that notice was, in fact, given.
The notice gives the beneficiary reasonable time to exercise his or her rights to withdraw the gifted property. Most IRS Rulings have approved withdrawal periods of between 15 and 30 days. Where the beneficiary is a minor, the notice should be delivered to the guardian of the minor. Where the beneficiary is disabled, the notice can be delivered to the conservator or a person holding a Power of Attorney for the disabled person.
The beneficiary does not exercise the right of withdrawal and the property stays in the trust to be managed and distributed by its terms.
But What if the Beneficiary Demands the Money?
The idea of Crummey powers is to qualify gifts to the trust for gift tax exemptions but to leave the assets in the trust to be held as planned by the Grantor. But what if the beneficiary, upon receipt of the notice, says, “I want my money”? The Trustee has no option but to give the beneficiary the money; generally the beneficiary’s pro rata share of the gift to the trust, but not more than the gift tax exclusion. If this happens, the Trustee and the Grantor will remind the beneficiary that to exercise the withdrawal rights will defeat the long term plans of the Grantor and will likely produce two results. First, the Grantor will not likely make any future gifts into the trust for the benefit of the beneficiary. Secondly, the Grantor may change his or her estate plan and appropriately punish the beneficiary. The cost could be great. Rarely will a properly educated beneficiary demand withdrawal of the gift to the trust.
Insurance Trusts
One specialized type of trust which always has Crummey provisions is an Irrevocable Life Insurance Trust. This is a trust that is primarily designed to hold a single asset, a life insurance policy on the Grantor. The purpose of this trust is to remove the life insurance proceeds from the estate of the Grantor and allow the proceeds to pass death tax free to the beneficiaries upon the death of the Grantor. This is accomplished by causing the life insurance on the Grantor to be owned by and payable to the trust.
Crummey provisions are necessary in a life insurance trust because of ongoing obligations to pay premiums each year. The steps which should be taken with respect to all life insurance trusts are as follows:
The Grantor should not pay the premium when it comes due. Rather, the Grantor should write a check to the Trustee of the trust and note it as a “gift” in the memo line of the check.
The Trustee receives and deposits the check.
The Trustee issues a Crummey notice to each and every beneficiary of the trust.
The Trustee pays the premium on the life insurance policy.
Failure to Follow the Rules
Following the rules seems like a lot of work for nothing. Are the lawyers and the IRS intentionally trying to complicate your life with paperwork? Why is all of this important? To explain the importance, let’s look at an example. Assume the life insurance trust referenced above has two beneficiaries and owns a life insurance policy on the life of the insured. The premiums are substantial. They are $20,000 per year. Each year the Grantor makes a $20,000 payment or gift to the trust. If the Crummey rules are followed, not only should the life insurance be excluded from the estate of the Grantor for estate tax purposes, but all of the premium payments which were made are deemed to be tax free gifts and are likewise excluded from the estate of the Grantor.
If Crummey notices are not sent, and if the IRS challenges the trust and the gifts, the IRS will assert that the gifts to the trust were not made in compliance with the Crummey rules, and will add back to the Grantor’s estate all premiums paid. If the $20,000 premium was paid each year for 20 years and if no Crummey notices were ever issued to the beneficiaries, $400,000 in premiums could be added back to the Grantor’s estate. If the Grantor has a taxable estate, the failure to issue 20 notices over a 20 year period to each of the beneficiaries could cost the estate $200,000 in additional estate tax. That alone is a reason to follow the Crummey rules.
Conclusion
Crummey powers allow us to make gifts to trusts without gift tax concerns. The Crummey rules produce substantial estate planning benefits. Failure to follow the Crummey rules produces a crummey tax result.
A. Stephen McDaniel
Williams, McDaniel, Wolfe & Womack, P.C.
5521 Murray Avenue
Memphis, Tennessee 38119
901-767-8200
smcdaniel@wmww.com