Giving gifts to others can be personally fulfilling. It can also cost you financially, as the IRS is sure to get its share through the federal gift tax. In 2014, the gift tax rate is 40%. Fortunately, we are all allowed an annual gift tax exclusion of $14,000 per recipient. The catch is, the exclusion only applies when you give money to someone immediately. But what if you want to create a trust? In that case, the “gifts” you make to the trust are taxable – unless you make use of Crummey Powers.
Why do gifts to a trust incur taxes?
The annual gift tax exclusion applies only to gifts that are of “present interest.” That means the person must receive an unrestricted right to “immediate possession, use and enjoyment” of that particular gift. For example, a birthday check, which allows your nephew to spend the money any way he chooses, transfers a present interest. On the other hand, an irrevocable trust, to which your granddaughter does not have access until she reaches a certain age, is a gift of a future interest. The annual gift tax exclusion of $14,000 does not apply to trust funds.
The definition of a Crummey Power
A Crummey power is a provision that can be included in certain irrevocable trusts, to gives the trust beneficiaries the ability to withdraw gifts from the trust, for a limited period of time. Because the option to receive the money immediately exists, the trust can be considered a gift of present interest. That way, those gifts will qualify for the federal annual gift tax exclusion. Without a Crummey power provision, any gifts you make to your irrevocable trust will be subject to the current gift tax of 40%.
The provision is referred to as a “Crummey” power because of the 9th Circuit opinion upholding the effectiveness of this technique. See Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968). This method is more valuable than others because it does not place restrictions on the provisions of the trust regarding disposition of the assets after the right of withdrawal period ends.
How does the Crummey Power provisionwork?
When you transfer funds to an irrevocable trust, containing a Crummey power provision, the trustee will give notice to each beneficiary. The notice will inform the beneficiaires that the funds can be withdrawn within a certain period of time, typically 30 days. Regardless of whether the beneficiaries actually withdraw the money, those gifts still qualify for the annual gift tax exclusion. If the withdrawal right is not exercised, the trustee can use the gifts for other purposes, as permitted in the trust agreement.
The Crummey Provision must be drafted correctly
It is not uncommon for the IRS to challenge these provisions, as they can be seen a way around the gift tax. This is especially true when it appears the beneficiary is not actually expected to exercise the power to withdraw from the trust. One way to avoid this problem is to be sue there is no express or implied agreement between the parties to the trust that the withdrawal power will not be exercised. In other words, there should not be any language, express or implied, that withdrawals are discouraged or prohibited. Nor should there be any option for the beneficiary to waive the right to withdraw. Another red flag is including Crummey power to a beneficiary who does not have a substantial economic interest in the trust.
If you have questions regarding Crummey Powers, trusts, or any other estate planning needs, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.