The Crummey Trust

*Grandchildren by Tod Baker is licensed under CC 2.0. *

In previous posts, I discussed the interaction of the federal estate and gift taxes. As discussed, one method of avoiding the estate tax is to gift away property during the course of your life, thereby lowering the value of your estate at death. Because of the gift tax’s service as a backstop to the estate tax, careful use of the annual exclusion is necessary to achieve these goals. The annual exclusion amount is currently $14,000 but is periodically adjusted for inflation.

Use of Trusts

One way to gift away property during your life while still maintaining some level of control is through the use of irrevocable living trusts. Unlike revocable living trusts, property gifted to an irrevocable living trust is considered outside of the giver’s estate because the trust cannot be revoked.

Great care must be taken in creating these trusts, however, as retaining too much control over the trust property may result in its contents being considered part of the giver’s estate for estate tax purposes. Therefore, irrevocable living trusts should be created with the close assistance of a competent attorney.

Once an irrevocable living trust is properly created, however, an easy solution to mitigate an estate tax bill becomes apparent: make all of your children, grandchildren, and whoever else you would like beneficiaries of the trust, so that you can take advantage of the annual exclusion amount for each beneficiary. (So, for example, if you named ten beneficiaries to the trust, you could gift away $140,000 to the trust without any gift tax implications.) Like most obvious tax mitigation strategies, however, the government has put in place measures to block its use.

Like so many federal regulations that appear to be little more than job creation programs for attorneys and accountants, only gifts of present interests can take advantage of the annual exclusion. A gift to a trust is often a gift of a future interest and can therefore not utilize the annual exclusion. Crummey Trusts, however, offer a solution to this problem.

The Crummey Trust

A Crummey Trust ensures that a gift to a trust qualifies as a present interest, so that the donor can take advantage of the annual exclusion. These can, however, be quite complex to administer, and so should be set up only with the assistance of competent counsel.

A Crummey Trust requires that the beneficiary of the trust to have a withdrawal right. While the donor can limit the amount that can be withdrawn, any limitation will be unable to take advantage of the annual exclusion amount. Consequently, the limitation is sometimes set at the annual exclusion amount. In an interesting quirk, however, any amount that lapses above $5,000 or 5 percent of the value of the trust is not considered a present interest gift and will therefore be subject to taxation. So, if the trust provides the right to withdraw up to the annual exclusion amount, currently set at $14,000, but the beneficiaries fail to take advantage of those withdraw rights before they lapse, or expire, a taxable gift of $9,000 results (assuming for this example that the trust is worth less than $100,000). Consequently, most Crummey Trusts simply limit the withdrawal amount to the greater of $5,000 or 5 percent of the value of the trust. Others allow the difference between $5,000 or 5 percent of the trust and the annual exclusion amount to remain in effect, creating a hanging power that the beneficiaries can exercise at any time. Individual circumstances and desires will determine how best to draft the trust.

The following is a list of requirements for a Crummey Trust:

1. The beneficiary must have a legal demand right, which is the right to actually withdraw the property from the trust.
2. The beneficiary must be given adequate notice of the demand right in writing. There is no hard and fast rule regarding the required notice period. Though as little as a week has been found sufficient, it is best to provide more time than that. Failure to send out these “Crummey Letters” may not disqualify the gift from taking advantage of the annual exclusion, but it is very wise always to send out the letters anyway.
3. The beneficiary must be given the opportunity to exercise the demand right. A 15 to 30 day window is generally considered reasonable.
4. The beneficiary must actually have some kind of interest in the trust property.
5. If the beneficiary is a minor, then the beneficiary must have the ability to have a guardian appointed if it is needed.
6. The beneficiary must be able to exercise the demand right without any threat of adverse consequences.

The beneficiary’s withdrawal rights are limited annually to the amount of the gift for that year, though the donor can limit that amount further. If the beneficiary does not exercise withdrawal rights, the property becomes part of the trust. Because the beneficiary had the ability to withdraw, however, the gift is considered to be a present interest gift and therefore eligible to take advantage of the annual exclusion amount.

Why Utilize a Crummey Trust?

Of course, a withdrawal right creates a risk. You may not want the beneficiaries to be able to withdraw property right now. This provision therefore seems to undercut the very purpose of creating a trust rather than giving a gift outright. Further compounding the complexity, you cannot threaten adverse action against a beneficiary to prevent them from exercising those rights.

This is one of the law’s wink-and-a-nod type situations. You cannot threaten a beneficiary, but the purpose of using a trust rather than giving an outright gift is often implicitly understood. Beneficiaries therefore generally understand that exercising their right one year will result in the cessation of future gifts, and therefore the Crummey Trust generally works well as an effective estate-planning tool.

Again, however, you must be careful not to threaten such cessations. The situation itself may imply adverse actions for exercising the right, but you yourself cannot promote such a threatening atmosphere without subjecting the utilization of your annual exclusion to possible disallowance.

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See Also:

The Federal Estate Tax

Irrevocable Living Trusts