Crummey Powers – Often Overlooked

When making annual exclusion gifts, typically while funding an Irrevocable Life Insurance Trust (ILIT), it is imperative that Crummey notices be provided to the beneficiaries of the qualifying gift. Without this notice, the IRS can attack the gift, causing it to become a future gift versus a present value gift and eliminating the use of the current $14,000 annual gift exclusion.

Often ignored or left behind are the Crummey notices that the trustee must provide to the beneficiaries upon receiving an annual gift to the trust. Even though there have been favorable tax court decisions, the IRS continues to scrutinize ILIT contributions and whether they qualify as annual exclusion gifts or not. If properly administered, Crummey notices will allow for the use of recurring annual exclusion amounts versus potentially paying gift taxes or losing lifetime gifts/estate and GST exemptions which could be very costly to the heirs.

Typically the first $14,000 of an annual gift to a donee will be excluded from Federal gift taxes. However, this gift will only qualify if the donee has a present interest in the gift similar to an outright gift. Most ILITs do not provide the ability to satisfy the present interest requirements. Instead they will include a power that allows the trust beneficiaries to withdraw some or all of the gift made to the trust. This provides the present value interest needed to satisfy the annual exclusion gift.

Although it seems simple, Crummey powers do require careful attention in administration since the IRS continues to focus on their use. When planning for Crummey powers, one must consider some of the following attributes:

  1. Determining how much the annual funding to the ILIT will be. If the annual gift is large, then sufficient Crummey power holders will be required to manage the payment of the insurance premiums.
  2. When determining the Crummey power holders, it may be necessary to determine which beneficiaries should be power holders and which should not. If a beneficiary is estranged from the family or has trouble managing finances or has creditor issues, then that beneficiary may not be a credible power holder. Many times the trust can address the flexibilities and possibilities of changing times and circumstances among and within the beneficiary power holders. This allows the trustee and donor to determine which beneficiaries should be allowed as a Crummey power holder.

Due to certain restrictions spouses should be limited to their withdrawal powers to no more than $5,000 or 5% of the trust if the donor intended to allocate Generation Skipping Transfer (GST) tax exemptions to the trust.

Another class of Crummey power holders could be grandchildren who would be considered Skip Persons for GST purposes. This allows for an expanded Crummey annual exclusion gift. It is important to remember that the annual exclusion gift does not automatically qualify for the annual GST tax exclusion. Therefore, donors will need to allocate these Skipped Persons Crummey power holders GST exemptions when filing the Form 709.

It is important to take into account other annual exclusion gifts as well. If other gifts are being made by the donor to the donees of the ILIT, those gifts must be taken into consideration in order to make sure that the donor does not exceed the $14,000 annual exclusion limit. This would include any 529 plan gifts.

A methodology of expanding the annual exclusion from $14,000 to $28,000 per year would be the use of gift-splitting between spouses. This allows the gift made by one spouse to be treated as though it was made by both spouses. The donor spouse must consent to the gift splitting. Consent will apply to all gifts made during the year, including as mentioned above 529 gifts or any other gift. There are certain limitations as to whether a spouse can consent or not. As an example, if the trust is to provide the non-donor spouse as a beneficiary of the ILIT, then the trust must provide that any discretionary spousal interest is subordinate to the exercise of the Crummey powers held by third parties. In structuring the Crummey power, especially if there are GST provisions, it is important to remember that the maximum gift is not the $14,000 annual exclusion but instead $5,000 or 5% of the aggregate value of all assets of the trust, also known as the 5 and 5 power. Naturally, if the contribution gift to the trust is greater than the 5 and 5 the trust must have a mechanism in which to hang the additional amount of gift. This hanging Crummey power lapses each year only to the extent of the 5 and 5 amount. The amount that is not absorbed will end up being in the taxable estate of the beneficiary.

The tax courts and the IRS, unfortunately, have taken conflicting opinions as to the requirements for providing power holders with notice. The IRS’s position is a power holder must have notice of their withdrawal powers. The IRS feels a 30 day withdrawal period is sufficient for the notice. Conversely, the tax courts have ruled that actual knowledge or notice of withdrawal rights did not affect the Crummey power holders legal right to demand withdrawals and that a withdrawal period of 15 days was reasonable. Despite the tax court rulings, the IRS continues to review and challenge ILIT contributions and their qualifications as to present value gifts.

Lastly, satisfying the withdrawal is critical and should be addressed within the ILIT. If the ILIT does not have the ability to satisfy the withdrawal request, then those Crummey powers may be deemed illusory. This could occur when the grantor pays the premiums directly to the insurance carrier bypassing the trust. Theoretically it’s best that the contribution/gifts are made to the ILIT trustee who then holds the contribution for the requisite period of time after giving the Crummey notice providing the power holders the time to withdraw. If this does not occur, then the agreement is best backed-up by allowing the exercise of the withdrawal to be satisfied by distributions in kind, borrowing against the insurance policy’s cash values and/or cash.

The proper administration of these notices can mean the difference between transferring property with only the use of recurring annual exclusion gifts versus potentially paying gift taxes or losing lifetime gift/estate and GST tax exemptions.