Considerations when combining Crummey powers with total discretionary trusts.

• Author: Tiernan, Peter B.

Total discretionary inter vivos trusts (1) provide a variety of benefits. For example, no one would deny the advantages that a sprinkle trust provides in taking care of the needs of multiple generations. Similarly, total discretionary trusts provide needed protection when an individual cannot hold onto money or has an addiction. The trustee in such a case could control what, if anything, is distributed. Adding a Crummey power to this type of trust produces certain consequences. The purpose of this article is to examine those consequences and how to deal with them.

The inclusion of Crummey powers in a trust converts transfers which otherwise would be future interest transfers into transfers of present interests. Only present interests qualify for the gift tax annual exclusion under I.R.C. [section]2503(b). Should Crummey powers be included in total discretionary trusts? Assuming the settlor's primary purpose is to protect a beneficiary who cannot handle money or has an addiction, then giving a Crummey power to that beneficiary is clearly not the best approach. Likewise, if a beneficiary has a tax lien against him or her, the Florida Trust Code permits a creditor to reach what the power holder can withdraw. (2) However, even in these two instances, gift tax savings can still be achieved by giving Crummey powers to the remainder beneficiaries of the trust.

Crummey powers might be particularly beneficial when the settlor is concerned about potential future creditors of the beneficiary, i.e., my son, the uninsured doctor. In such a case, Crummey powers could be provided to both the son and the remaindermen. This would provide gift tax savings since it would permit the maximum amount of gift tax exclusions during the time that the son has no creditors. But what should be done once a malpractice judgment is rendered?

In TAM 8901004, the IRS permitted a settlor of a trust to exclude persons holding powers of withdrawal from exercising those powers in connection with future contributions to the trust. This ability to exclude a future exercise of a Crummey power is something to consider in every total discretionary trust when the settlor's purpose is to provide protection against possible future creditors. Under the Florida Trust Code, a creditor can reach the maximum amount that can be distributed to or for a power holder's benefit. However, with this exclusion power, a settlor can protect the trust against the claims of any such future creditors.

GST and Gift Tax Considerations with Crummey Powers

There are GST issues with many total discretionary trusts. Consider, for example, a trust created for a child who has problems holding on to money or has creditor problems. With such a trust, the child's children (the settlor's grandchildren) will most likely be named as remainder beneficiaries. This is a classic generation-skipping scenario. However, since the child (a non-skip person) is a permissible current noncharitable recipient of income or corpus, he holds a Ch. 13 interest in the trust. (3) If a non-skip person holds a Ch. 13 interest in the trust, then the trust is not a skip person. (4) Therefore, there is no direct skip on any transfers made by the settlor to the trust. With such an arrangement there would normally be no GST consequences until the child's death. (5)

The gift and GST consequences of including Crummey powers with total discretionary intervivos trusts are similar but not identical to the consequences when a Crummey power is included in the typical irrevocable inter vivos trust (i.e, a support type trust). Because of the significance of these consequences, however, a review of the applicable tax law is both warranted and beneficial.

Consequences for a Grandchild

What are the gift and GST consequences to a grandchild when he or she does what the settlor presumably wants and permits his or her Crummey power to lapse? These possible consequences depend upon whether the lapse of the grandchild's Crummey power is treated as a release. Generally, a lapse of a Crummey power is treated as a release. (6) This rule is subject to one important exception. A lapse of a general power of appointment (i.e., a Crummey power) is not treated as a release to the extent it does not exceed the greater of $5,000 or five percent of the value of the trust as of the date of the lapse (herein referred to as the safe harbor amount). (7)

There are two deemed consequences, for GST purposes, whenever the lapse of a Crummey power is treated as a release. First, there is a deemed distribution/transfer by the trust to the power holder. (8) Absent such a deemed distribution/transfer, there can be no taxable distribution or taxable termination occurring. Second, if a lapse is treated as a release, there is a deemed transfer by the power holder to the extent the power holder is treated as making a completed transfer for purposes of Ch. 12. (9) A deemed transfer is necessary for finding that the power holder is a transferor for GST purposes.

For example, assume 1) the settlor contributes $5,000 to a trust during the year; 2) the trust has current assets of $50,000 (after the contribution); 3) the grandchild has the right to withdraw the entire $5,000 contributed; and 4) the grandchild allows his or her withdrawal right to lapse.

The safe harbor amount in this example is $5,000 (the greater of $5,000 or $2,500 [five percent of $50,000]). The amount that has lapsed is within the safe harbor. It is, therefore, not treated as a release. (10) Since there is no release, there is no deemed distribution of this amount from the trust to the grandchild (i.e., no distribution to a grandchild that could constitute either a taxable distribution or taxable termination). Further, there is no deemed transfer by the grandchild back to the trust (no transfer that could constitute a GST transfer by the grandchild). Similarly, because the lapse is within the safe harbor amount, there is no lapse of the grandchild's power that is subject to gift tax. (11)

Compare the above to a power to withdraw amounts in excess of $5,000 or five...