The $11,000 gift tax annual exclusion ($12,000 for gifts made in 2006) is available only for gifts of present interests. A gift to a trust for the benefit of a particular beneficiary is usually a gift of a present interest only if the trustee is required to distribute all of the income of the trust no less frequently than annually. If a trust does not have income because its assets are invested in non-income paying property (e.g., unproductive real estate or artwork), a gift to that trust will be treated as a gift of a future interest.However, the exclusion is allowed for a gift in trust to a minor, if the trust property and the income from that property may be (but don't have to be) spent by or for the minor before he reaches age 21, and to the extent not so spent will pass to the minor when he becomes 21.
Observation: If the beneficiary has the power to withdraw, there's always the possibility that she might actually do so. In most cases, holders of Crummey powers understand that they're expected not to exercise their powers (although that expectation should always remain unwritten, because if there's any evidence of it, the Internal Revenue Service will use that evidence to say that the power was illusory). However, there's no guarantee that the power holder will honor that expectation. Separate grantors will sometimes tell the holder (but not in writing) that if the power is exercised, there may be no future gifts to the trust.
Example 1: Your client has four children, John, David, Louise and Barbara. He establishes Crummey trusts for each of them in 2005. David exercises his power of withdrawal to withdraw the amount transferred to his trust in 2005. Your client plans to make no contribution to David's trust in 2006.
For the power of withdrawal to be effective, the beneficiary (or his guardian, if the beneficiary is a minor) should be given a notice in writing of his right of withdrawal at the time of the original transfer to the trust, and should be notified again whenever additional contributions are made to the trust. It's also advisable to have the beneficiary (or the guardian) acknowledge receipt of the notice by signing a copy of the notice and returning it to the trustee. This will serve as proof that the notice was actually given.
Recommendation: The fact that the beneficiary is a minor doesn't bar the allowance of the annual exclusion for gifts to the trust, provided there is no impediment under the trust or local law to the appointment of a guardian. To avoid any question about whether state law would permit a guardian to exercise the power of withdrawal in the absence of express authorization, include a provision in the trust agreement authorizing the guardian of a minor or incompetent beneficiary to exercise the power on behalf of the beneficiary.
However, the grantor of the trust should not be given the power to exercise the withdrawal power on the beneficiary's behalf, even if the grantor is the guardian. If the grantor does have the ability to exercise the power, the property subject to the power could be includible in his gross estate under either the retained life estate rule of Internal Revenue Code §2036, or the revocable transfers rule of IRC §2038. If the grantor is the beneficiary's guardian for other purposes, someone else should be authorized to act as guardian for the purpose of exercising the Crummey power on the beneficiary's behalf.
You don't have to give notice to the beneficiary if the trustee is the guardian of a minor beneficiary and is authorized, as guardian, to exercise the power on the minor's behalf.
* Don't have beneficiary waive right to notice. It's not advisable to have a beneficiary waive the right to notice of future contributions, since it creates a risk that the annual exclusion will be disallowed for those contributions. The IRS ruled privately that, where beneficiaries waive the right to receive notice regarding their right to withdraw future gifts to a trust, annual exclusions were allowable only for the initial transfer to the trust.
The IRS also took the position that, because of the waiver and the lack of proof that notice of later gifts was actually given, all transfers to the trust after the initial transfer were gifts of future interests.
* Reasonable time to exercise Crummey power required. The beneficiary must be given a reasonable period of time after receiving the notice to exercise her power of withdrawal before it lapses. Thirty days is probably the shortest period that can safely be considered reasonable. The service has ruled on several occasions that 30 days is adequate notice. It has also said that a 20-day withdrawal period so severely restricts the time in which a withdrawal right can be exercised as to suggest that the grantor of the trust never intended that the beneficiaries ever exercise their rights.
* Where trustee has power to distribute principal to someone other than power holder. If the trustee has the discretionary power to distribute trust principal to anyone other than the holder of the Crummey power, provide in the trust agreement that the Crummey power takes precedence over the other power.
Otherwise, the exercise of the trustee's discretionary power could defeat the Crummey power holder's interest in the trust (since the property out of which the power holder's interest could be satisfied may have previously been distributed to other beneficiaries). As a result, the Crummey power holder's interest won't qualify as a present interest and the gift tax annual exclusion will be lost.
* Consider limiting power of withdrawal. To take full advantage of the annual exclusion, the Crummey power holder should be given the right to withdraw an amount equal to the gift tax annual exclusion ($11,000 in 2005, $12,000 in 2006) each year from the trust. If the donor's spouse splits gifts with the donor, the power to withdraw could be twice the annual exclusion.
However, if the power holder can withdraw more than the greater of $5,000 or 5 percent of the principal of the trust, the power holder may be treated as having made a taxable gift when he allows the power to lapse (as he almost always does). That's because a Crummey power is a general power of appointment, and the lapse of a general power of appointment is treated as a taxable gift to the extent that the property that could have been appointed by exercising the lapsed power exceeds the greater of $5,000 or 5 percent of the total value of the assets out of which the exercise could be satisfied.
Example 2: Your client has a Crummey power to withdraw $11,000 a year from trust principal. His failure to exercise his power in any year isn't a gift if the value of the trust principal, at the end of that year, equals or exceeds $220,000 (because 5 percent of $220,000 is $11,000). But if the trust principal were worth only $120,000, the non-exercise of the power would result in a gift to the extent of $5,000 (the excess of $11,000 over the greater of $5,000 or $6,000 (5 percent of a fund of $120,000)).
To avoid having the beneficiary be treated as making a taxable gift when he allows the power to lapse, limit the amount of his power to the greater of $5,000 or 5 percent of the value of the assets out of which the exercise of the power could be satisfied (a so-called five and five power), if it is feasible to impose such a limitation.
You can't get around this problem by giving the beneficiary the right to withdraw $5,000 from each contribution made to the trust, and then making more than one $5,000 contribution to the trust in a year, or by creating multiple trusts for the same beneficiary and giving the beneficiary the right to withdraw $5,000 per year from each trust. The IRS has ruled that, in both those situations, all the Crummey powers possessed by the beneficiary have to be aggregated for purposes of determining whether the lapse of the powers results in a taxable gift.
However, there are several other ways of avoiding a taxable gift where the beneficiary's power isn't subject to a five and five limitation.
One way to avoid undesirable gift tax consequences to the power holder if the power is not subject to a five and five limitation is to make him the sole remainderman of the trust, and to provide that his estate will receive the trust principal if he dies before the trust terminates. In this situation, the lapse of the power doesn't result in a taxable gift because there are no other beneficiaries to whom a property interest is transferred by reason of the power holder's failure to exercise his withdrawal power.
However, if this is done, the entire trust principal will be includible in the power holder's gross estate if he dies before the termination of the trust. This will not be a problem if the power holder's estate is not large enough to be subject to a federal or state estate tax.
Another way to avoid undesirable consequences to the power holder if his power is not subject to a five and five limitation is to give him a testamentary power of appointment over the trust principal if he dies before the trust terminates. Here, the lapse of the power doesn't result in a taxable gift because the power holder's ability to control the disposition of the trust assets makes the lapse an incomplete transfer.
Doing this will cause all or part of the trust principal to be includible in the power holder's gross estate if she dies before the termination of the trust. If the power of appointment is a general power (i.e., a power exercisable in favor of the holder of the power, her estate, her creditors or the creditors of her estate), the entire trust principal will be includible in her estate. If the power is a special power of appointment (i.e., a power not exercisable in favor of the holder of the power, his estate, his creditors or the creditors of his estate), only a part of the trust property will be includible in his estate.
A third way to avoid undesirable gift tax consequences to the power holder if his power is not subject to a five and five limitation is to give him a hanging power. A hanging power is a power that lapses each year only to the maximum extent permissible under the five and five limitation. To the extent that the power exceeds the five and five limitation, it doesn't lapse, but hangs, or carries over, into later years until such time as its lapse does not trigger a taxable gift.
