They are often referred to as "Crummey Trusts" and attorneys have been preparing them for clients since the late 1960s. Properly drafted and executed, these trusts can help taxpayers transfer significant wealth by leveraging the annual gift exclusion, particularly when the underlying trust asset is life insurance. In addition, these if these gifts to the trust beneficiaries "lapse," then they are used to pay the insurance premiums and are further protected by the trust terms both "for" and even "from" these very beneficiaries.
Blah, blah, blah....
Is your head about to explode?
The IRS does not like Crummey Trusts. Surprised?
The IRS seeks to challenge Crummey Trusts and their underlying Crummey powers (the secret sauce) and upset the tax planning applecart every time it encounters one it really does not like.
The Mikel's story is told in a recent Forbes article titled “Religious Arbitration Clause Does Not Hurt Million Plus Gift Tax Exclusion.”
The original article reminds us, in a powerful way, that there is an annual exclusion from gift tax.
Reminder: every year you can give the annual exclusion amount ($14,000 this year) to as many people as you want without any gift taxes or disturbing the unified credit against transfer taxes.
However, to qualify for the exclusion, the gift has to be of a “present interest”.
Therein lies the rub.
When you make gifts to the children, grandchildren and even the spouses of same, you really do not want to hand them cash at that very moment, do you?
Likely, you want the money in the hands of a trustee who will distribute it to them responsibly.
So, how do you get around this apparent “present interest” conundrum?
Well, the original article explains how the Crummey power is a way around this problem.
In short, here is how it works:
Money or property goes into the Crummey Trust and the trustee is directed to notify the beneficiaries who get a short time to withdraw up to the annual exclusion amount (I use 30 days). However, beneficiaries are (indirectly and never in writing) discouraged from doing this.
You did not hear that from me, okay?
Consequently, it is rare that a beneficiary makes a grab for the cash.
Nevertheless, folks worry about this and oftentimes put provisions in their trusts to discourage the beneficiaries from withdrawing the assets.
In the case of Israel and Erna Mikel, each made gifts to a family trust with an “asserted value” of $1.6 million, and each claimed annual exclusions of $720,000.
When the Mikels made these gifts in 2007, the annual exclusion was $12,000. Doing the math, that means 60 people had withdrawal rights. According to the court decision, these 60 beneficiaries were all lineal descendants or spouses of descendants.
The IRS disallowed the exclusions claiming that the beneficiaries lacked legally enforceable rights to withdraw the funds.
Once the Crummey power lapsed, there was no guarantee that any beneficiary would get anything from the trust.
Furthermore, the trust provided that any disputes concerning the interpretation of its terms would be submitted before a “Beth Din” panel, which consists of three persons of the Orthodox Jewish faith.
Along the same lines, there is yet another trust provision stating that if a beneficiary litigates a distribution of the trust, that beneficiary's interest will be revoked.
This is called an “in terrorem” clause in the estate planning world.
With all these restrictions, the IRS argued that the withdrawal rights were not “legally enforceable.”
The Tax Court disagreed.
The Court believed that the “in terrorem” clause was much more limited and was there to emphasize the trustee’s broad discretion to make distributions. In effect, it would only be triggered if a beneficiary brought a suit that challenged an actual distribution to another beneficiary.
As a result, the beneficiary did have an enforceable right to demand a distribution during the Crummey window (even though, again, beneficiaries never do that in practice).
Contact an experienced estate planning attorney who explain this in greater detail.
This is not a do-it-yourself plan, by the way.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
For more information about estate planning in Overland Park, KS (and throughout the rest of Kansas and Missouri) and to download free tools to help you organize your estate, visit my estate planning website.
Reference: Forbes (May 11, 2015) “Religious Arbitration Clause Does Not Hurt Million Plus Gift Tax Exclusion”