When creating a comprehensive estate plan, it is important to keep in mind the old adage that no good deed goes unpunished; or at least, untaxed. While your intentions may be to provide for your loved ones during your lifetime and after your death, most financial decisions you make concerning your estate plan will have tax ramifications for you, your loved ones, or all. Meeting with an estate planning attorney and/or financial advisor will help ensure you have the best plan for your specific estate and minimize your tax exposure. One instrument many practitioners encourage grantors to use to limit their tax exposure is a Crummey trust.
A Crummey trust is a specialized trust, which allows the grantor to make gifts to loved ones while also taking advantage of the Internal Revenue Service’s (“IRS”) annual gift tax exclusion. In short, the Crummey trust provides beneficiaries with a short window of time in which they may choose to withdraw contributions made to the trust. However, the idea behind the Crummey trust is that beneficiaries forego these withdrawals and instead allow the trust principal to grow, until a specified distribution time provided for in the trust provisions.
IRS Gift Tax
To understand the benefits of a Crummey trust, you must first understand the IRS gift tax. According to the IRS, “[t]he gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return.” Essentially, whenever you gift something of value to someone, and you receive nothing in return, you are making a gift that may be subject to the IRS gift tax. As the donor, you are generally responsible for paying this tax.
Fortunately, there is a provision in the tax code, which allows for an annual gift tax exemption. Generally, to qualify for this exemption, the gift you made: (1) must be on a present interest (more on this below); and (2) must not exceed the annual gift tax exclusion amount. For 2020, the annual gift tax exclusion amount is $15,000. The exclusion applies to each “donee,” i.e. the person to whom the gift is given. For example, if you have three children, you could give each child $15,000 in 2020. You would give away $45,000, but because the annual gift tax exclusion applies to each donee, you would not be liable for the gift tax. The annual exclusion is doubled to $30,000 per year for married couples giving a joint gift. Therefore, you and your spouse could gift your children a total of $90,000 a year and not be liable for gift taxes.
Given that your goal would be to provide a gift to your loved ones, it is understandable that you may want to try to avoid paying taxes on that gift, legally of course! The Crummey trust provides one mechanism of possible tax circumvention, explained below.
Creation of a Crummey Trust and Crummey Powers
At first glance, a Crummey trust looks like any other irrevocable trust. There is a grantor, who creates the trust and places assets into the trust as trust property, and there are trustees and beneficiaries. A trustee is chosen by the grantor and administers the trust in accordance with the trust provisions, for the benefit of the beneficiaries. Further, a Crummey trust is irrevocable, meaning the grantor retains no control over the trust. All the property the grantor places into the trust is considered trust property and is no longer part of the grantor’s estate. Therefore, usually, the grantor is no longer liable for taxes on said property (generally, the trust and beneficiaries are).
A Crummey trust has one major difference from your standard irrevocable trust: the beneficiary has a temporary, present interest in the trust property. A “present interest” is an unrestricted right to the immediate use, possession, or enjoyment of the property or the income from it. This differs from most irrevocable trusts where the gift is placed into the trust, and it accumulates income without being distributed to the beneficiary. The beneficiary has a future right to the property, usually after the occurrence of some event, and not a “present interest,” making the contribution subject to gift tax.
A Crummey trust creates a temporary, present interest in the trust property (gift). This temporary, present interest is what allows the property placed into the Crummey trust to qualify for the annual gift tax exclusion. To create a temporary, present interest, the grantor generally includes trust provisions explaining that the beneficiary would be entitled to withdraw the annual contributions made to the trust at the time such contributions are made (sometimes referred to as “Crummey powers”). Most Crummey powers give the beneficiary a period of time in which he or she may withdraw the contribution (typically within 30, 60, 90 days from contribution). If the beneficiary does not withdraw the contribution within the set time period, the withdrawal period lapses, and the contribution becomes part of the trust principal. This allows the trust principal to grow and accumulate in value, while also avoiding gift taxes.
Crummey Letter (Notice to Trust Beneficiaries)
Importantly, to qualify for the gift tax exemption, the beneficiary must always be given both notice of the contribution to the trust and the opportunity to withdraw said gift from the trust. This is the very essence of a Crummey trust. Any trust that does not provide the beneficiary notice of their withdrawal powers or that limits the beneficiary’s right to withdraw the funds is at risk of attack from the IRS and may suffer unwanted tax consequences.
To ensure compliance with gift tax exemption rules, the trustee should notify each beneficiary in writing each time a contribution to the trust is made. This notification is known as a “Crummey letter.” The following are examples of information that should be contained within a standard Crummey trust letter sent to beneficiaries:
- “Under certain provisions of the trust agreement, you have the following rights of withdrawal as beneficiaries:
- Each time a contribution is made to the trust, each beneficiary of the trust has a 30 day right to withdraw an amount equal to the amount of the contribution divided by the number of persons holding withdrawal rights.
- This 30-day withdrawal right commences upon the individual beneficiary’s receipt of a notice from the Trustee advising him or her of the existence of the withdrawal right.
- The most that a beneficiary can withdrawal using the withdrawal right is $15,000. When 30 days have passed following a beneficiary’s receipt of notice of the withdrawal right, the right lapses.
- The Grantor has taken no action to eliminate rights of withdrawal arising in connection with this contribution. The beneficiaries have the right to withdraw their share of the amount contributed this year, up to $15,000.
- The purpose of this letter is to advise you that you have the right to withdraw the amount contributed by the Grantor to the trust between *contribution date* and the date of this letter. The applicable amount is no more than $15,000 per beneficiary.
- The right of withdrawal will continue for 30 days from the date you receive this letter. If the right is not exercised within the 30-day period, or if you waive the right to withdraw, it will lapse and the contributed funds will remain in trust to be administered in accordance with the provisions of the trust agreement.
- If you wish to exercise the right of withdrawal, please send me a written statement of your wish to exercise the withdrawal right within the 30-day period (parents may do so on behalf of minor children).
- For my records, I would appreciate you signing the Acknowledgement at the end of this letter and returning it to me in the envelope provided, even if you do not intend to exercise your withdrawal right. This will provide me with evidence that you have received this notice.”
It is vital that the trustee send a Crummey letter to each beneficiary each time the grantor contributes to the Crummey trust. Further, it is important that each beneficiary sign an acknowledgment that he or she received the Crummey letter. These measures protect against an attack by the IRS concerning whether the contribution qualifies for the gift tax exemption because the trustee may provide evidence that each beneficiary received notice of the right to withdraw the gift. The right to withdraw the gift is the present interest in the trust property, which is required for the gift tax exemption.
It is important to note that a beneficiary should not waive their right to receive the contribution. Such waiver may be seen as a gift to other beneficiaries and may be subject to the gift tax. Rather, the beneficiary should simply allow their withdrawal time period to lapse.
Beneficiary Right to Withdraw
As discussed above, in Crummey trusts, beneficiaries should always have the right to withdraw trust funds during a certain time period. While the grantor may explain to beneficiaries the benefits of keeping assets in the trust, there cannot be an express or even implied agreement between the trustee or the grantor and the beneficiaries that the beneficiaries should not exercise their withdrawal power. If a grantor is unhappy that a beneficiary exercised their withdrawal power, the grantor may choose to stop funding the trust. However, there should never be an agreement between the grantor and the beneficiary that the beneficiary’s future rights to withdraw will not be exercised or the IRS could consider the present interest a nullity.
Beware: the 5 and 5 Rule
As discussed above, beneficiaries may let their withdrawal time period lapse without removing their portion of the contribution/gift. While this helps the trust principal to grow, there may be adverse tax consequences to this action. Allowing withdrawal rights to lapse may result in the beneficiary effectively conveying their gift (their right to the contribution that was not withdrawn) as a gift to other beneficiaries of the trust, unless the value of the lapsed amount does not exceed the greater of $5,000 or 5% of the value of the trust’s assets. This is known as the IRS’ “5 and 5” rule.
In keeping with the above example, if you create a Crummey trust with $30,000 in trust assets for your children, and in 2020 you gift to your three children, through the Crummey trust, $15,000 each, you escape the gift tax for the $45,000 in gifts. However, if each child allows the withdrawal period to lapse, the amount of gift money above what is allowed by the 5 and 5 rule is considered a gift to the other children/beneficiaries. Therefore, each child is deemed to gift $10,000, the remaining amount above $5,000, to their siblings who may be liable for the gift tax. Estate planning attorneys and financial advisors should be able to recommend techniques to minimize potential tax liabilities (such as the 5 and 5 rule) for you and your beneficiaries.
Consult an Estate Planning Attorney
The above information is merely an overview of Crummey trusts and should not be considered legal advice. As you can surmise from this article, Crummey trusts may be a useful estate planning tool when drafted and executed properly but are complicated and not without their possible pitfalls. If you are interested in forming a Crummey trust, you should seek the advice of a qualified estate planning attorney who knows the pros and cons of Crummey trusts and who can provide you with solutions that help you create the most advantageous estate plan for both you and your loved ones.
- Gift Tax, IRS, https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax
- Frequently Asked Questions on Gift Taxes, IRS, https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
- Instructions for Form 709 (2019), IRS, https://www.irs.gov/instructions/i709#:~:text=gift%20tax%20purposes.-,Annual%20Exclusion,purposes%20of%20the%20annual%20exclusion.
- Crummey Notices and Proper Estate Planning, Stimmel Law, https://www.stimmel-law.com/en/articles/crummey-notices-and-proper-estate-planning
- Everything You Need to Know About Crummey Trusts, The Virtual Attorney, https://www.thevirtualattorney.com/blog/crummey-trust#:~:text=1%29%20The%20trust%20must%20be%20irrevocable.%20The%20first,is%20that%20the%20Crummey%20trust%20must%20be% 20irrevocable
- Crummey Letter for Irrevocable Trusts, R.F. Meyer and Associates, https://www.elderlaw.us/wp-content/uploads/2017/12/Crummey-Letter-fillable-01-01-2018.pdf
- Don’t Let A ‘Crummey’ Mistake Ruin Your Trust, Palisades Hudson Financial Group, LLC, https://www.palisadeshudson.com/2010/06/dont-let-a-crummey-mistake-ruin-your-trust/