Will a Crummey beneficial interest qualify for an annual gift tax exclusion?

• Author: Schenkel, Kent D.

EXECUTIVE SUMMARY

* The IRS continues to embrace a theory it has maintained for a number of years--that a beneficiary's transitory right to enjoy the benefits of a gift in trust is not the only relevant test in determining the availability of the annual exclusion.

* While the Service has recognized the validity of the right-to-enjoy test, it has tried to proffer, in addition, another test before allowing the annual exclusion: the donor's intent that the beneficiary actually obtain some substantial additional benefit from the trust.

* To avoid annual exclusion challenges, the tax adviser should highlight the objective indicators of the client's benevolent intent: (1) the trustee should be required to give notice to beneficiaries of their withdrawal rights and (2) the trust agreement should allow a reasonable time period to make withdrawals.

Despite a number of pro-taxpayer court decisions, the IRS continues to deny the annual gift tax exclusion if a Crummey trust beneficiary has only a right to withdraw trust contributions, without some other economic interest in the trust. This article demonstrates how, even in the face of unfavorable judicial decisions, the Service continues to cling to this position, albeit with a new approach.

Irrevocable "Crummey trusts"(1) are one of the most powerful estate planning devices in use today. Their great utility stems from the fact that they qualify gifts for the Sec. 2503(b) $10,000 annual exclusion. This characteristic, combined with the post-gift control offered by a trust, adds up to a very effective tool for building up assets on the "home base" side of the transfer tax hurdle. Despite persistent IRS challenge, courts continue to support taxpayer interpretations of the law in this area, allowing annual exclusions to be obtained in a variety of contexts.

But tax advisers cannot afford to get complacent. Although recently the Service apparently abandoned one of its arguments for narrowing the scope of Crummey, it continues to embrace a theory it has maintained for a number of years-that a beneficiary's fleeting right to enjoy the benefits of a gift in trust is not the only relevant test in determining the availability of the annual exclusion. As this article explains, the IRS has consistently argued that the beneficiary's right to enjoyment must be accompanied by the donor's intent that the beneficiary actually obtain some substantial additional benefit from the trust. Recent rulings indicate that the IRS has found a new way to proffer this much-rejected contention.

The "Right to Enjoy" Test

Sec. 2503(b) permits taxpayers to transfer up to $10,000 per person per year free of gift tax, but gifts of future interests are not eligible. "Future interests" are defined by Regs. Sec. 25.2503-3(a) as interests limited to commence in use, possession or enjoyment at some future date or time. Most transfers in trust fall within this definition because the beneficiary's ability to use, possess or enjoy the gift is limited by the trust's terms. The Crummey power elevates the status of a gift in trust to that of a present interest, qualifying it for the annual exclusion.

The method is deceptively simple. Crummey powers give the trust beneficiary a limited opportunity to withdraw all or a portion of the donor's transfers to the trust. Because the beneficiary, by way of the withdrawal power, has a right to a present interest, he is deemed to have possession of the property subject to the withdrawal power, whether or not the power is actually exercised(2); courts have termed this the "right to enjoy" test.(3) Simply stated, if a demand of funds under the withdrawal power created by the trust cannot be legally resisted, the...