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"Crummey" Powers Aren't Crummy
Did your advisor blithely toss off technical terms and leave
you wondering why you should pay them to draft a trust with
"crummy" powers? They meant "Crummey" and thereby hangs a tale.
Very broadly, you may exclude from taxable gifts, gifts of up
to $10,000 per person per year. However, that exclusion does not
apply to gifts of "future interests". While outright gifts
qualify, most gifts in trust are future interests and ordinarily
wouldn't qualify for the exclusion.
Enter a brilliant attorney in California, who was drafting a
trust on behalf of his clients, the Crummeys. He provided that,
when the made gifts to the trust, their children would have the
right to withdraw such gifts for a period of time. After that
period, if they did not exercise such right, it would lapse and
the property would remain in trust. After losing a court battle,
the IRS conceded that such gifts would constitute present
interests and qualify for the exclusion. This enables people to
make non-taxable gifts in trust without giving their children
early access to the money.
Over the years, the rules have evolved and become definite,
although there are still areas in dispute.
The gift can be to a minor, who doesn't really have the power to
act, as long as some adult (guardian, parent, etc.) has the power
to make withdrawals on their behalf.
The beneficiary (or person on their behalf) must be informed of
the gift and their right. This is usually done by giving them
notice. In a private ruling, IRS has taken the position that they
must be given notice each time -- that they cannot waive the
right to notice. I disagree.
There may be no prearranged understanding that the beneficiary
will not exercise their withdrawal power. IRS has argued that if
remote beneficiaries don't exercise their powers, it is evidence
of a prior understanding. The courts have disagreed.
Although excluded from the gift tax, such gifts do not qualify
for exclusion from the Generation Skipping Transfer Tax . In such
case, annual non-taxable returns may be filed to apply the
exemption to the gifts, sheltering hopefully greater amounts that
it will grow to.
The latest legislative proposals would deny this exclusion from
gift tax.
Nothing is ever simple. A parent may give a child a lapsing right
to withdraw $10,000 and exclude the gift from the parent's tax
base. However, if the child allows to lapse a withdrawal power
greater than $5,000 or 5% of the trust, *the child* makes a
taxable gift. In order to minimize taxes at all levels, good
planning and drafting takes these limitations into account.
Crummey powers are particularly useful in the case of irrevocable
insurance trusts. They enable one to pay for tax-free insurance
without using up one's lifetime shelter.
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