Taxation of Lapsed Powers of Appointment
| Publication year | 1986 |
| Pages | 24 |
| Citation | Vol. 15 No. 1 Pg. 24 |
1986, January, Pg. 24. Taxation of Lapsed Powers of Appointment
Noncumulative powers of withdrawal are routinely given to beneficiaries of irrevocable inter vivos trusts in order to qualify additions to the corpus of the trusts as present interest gifts for gift tax purposes under the holding in Crummey v. Commissioner.(fn1) The powers are often limited to the lesser of the available annual gift tax exclusion or the value of the addition to the trust. They are exercisable each time an addition is made to the trust.
The surviving spouse is often granted a noncumulative annual power of withdrawal in the non-marital trust in the form of a power to withdraw the greater of $5,000 or 5 percent of the trust principal at the end of the calendar year. Powers of withdrawal are rarely exercised in the case of an irrevocable inter vivos trust and may or may not be exercised in the case of the non-marital trust, depending upon the needs of the surviving spouse. This article examines the income and gift tax consequences of the lapse of such powers of withdrawal.(fn2)
Powers of withdrawal are general powers of appointment under § 2514 of the Internal Revenue Code of 1954 ("Code"). Under Code § 2514(b), the exercise or release of a general power of appointment created after October 21, 1942, is deemed to be a transfer of property for gift tax purposes by the individual possessing the power. The lapse of a power of appointment is treated as a release by the individual possessing the power and is a taxable event for gift tax purposes. However, under Code § 2514(e), the amount subject to gift tax for any one calendar year is limited to the amount by which the value of the property subject to the lapsed powers exceeds the greater of $5,000 or 5 percent of the aggregate value of the assets out of which, or the proceeds of which, the exercise of the lapsed powers could have been satisfied (this is known as the "5-and-5 exemption").
In the case of successive Crummey powers in a single trust, an argument could be made that each addition to the trust provides a different fund for the exercise of the power and that a separate 5-and-5 exemption should be available with respect to the lapse of each power. In the case of multiple trusts, the question is whether more than one 5-and-5 exemption is available for lapses of powers held by a person who is a beneficiary of more than one trust. These issues were recently raised in Revenue Ruling ("Rev. Rul.") 85-88.(fn3)
In situation 1 of Rev. Rul. 85-88, a grantor created an irrevocable inter vivos trust and granted the income and remainder of interest to separate beneficiaries. The income beneficiary was also given the right to withdraw (within sixty days after receipt of notice) up to $5,000 from each contribution made by any donor to the trust. Two contributions of $5,000 each were made to the trust at different times during the calendar year and the income beneficiary allowed his powers of withdrawal as to each contribution to lapse during the same year. The ruling concludes that only one 5-and-5 exemption is available for the lapse of both powers and that the 5...
To continue reading
Request your trial