Is a Crummey Trust Right for You | San Jose Estate Tax Planning

The Tax Cuts and Jobs Act (TCJA) has reduced estate tax concerns for many families, but estate tax liability remains a concern for some. Notably, you may implement strategies in the wake of the TCJA that are designed to reduce future exposure to federal and state estate taxes.

One such option, a Crummey trust, remains a viable option. Despite its odd-sounding name, derived from the landmark case authorizing its use, the results are anything but crummy.

“Present interest” vs. “future interest”

Under the annual gift tax exclusion, you can give gifts to each recipient, valued up to a specific limit, without incurring any gift tax. The limit for 2019 is $15,000 per recipient, the same as it was in 2018. (This amount is indexed for inflation, but only in $1,000 increments.) Therefore, if you have, for example, three adult children and seven grandchildren, you can give each one $15,000 this year, for a total of $150,000, and pay zero gift tax. The exclusion is doubled to $30,000 a year for gifts made jointly by a married couple.

If you give outright gifts, however, you run the risk that the money or property could be squandered, especially if the recipient is young or irresponsible. Alternatively, you can transfer assets to a trust and name the child as a beneficiary. With this setup, the designated trustee manages the assets until the child reaches a specified age.

But there’s a catch. To qualify for the annual exclusion, a gift must be a transfer of a “present interest.” This is defined as an unrestricted right to the immediate use, possession or enjoyment of the property or the income from it. When a gift is placed in a trust and it accumulates income without being distributed to the beneficiary, it doesn’t qualify as a gift of a present interest. Instead, it is treated as a gift of a “future interest” that is subject to gift tax.

Crummey trust in action

This is where a Crummey trust can come to the rescue. It satisfies the rules for gifts of a present interest without requiring the trustee to distribute the assets to the beneficiary.

Typically, periodic contributions of assets to the trust are coordinated with an immediate power giving the beneficiary the right to withdraw the contribution for a limited time. However, the expectation of the donor is that the power won’t be exercised. (The trust document cannot expressly provide this.)

As a result, the beneficiary’s limited withdrawal right allows the gift to the trust to be treated as a gift of a present interest. Thus, it qualifies for the annual gift tax exclusion. Note that it’s the existence of the legal power — not the exercise of it — that determines the tax outcome.

Potential obstacles

To pass muster with the IRS, the beneficiary must be given actual notice of the withdrawal right, along with a reasonable period to exercise it. Generally, at least 30 days is required.

It’s recommended that you spell out the notification in writing. Also, you should obtain a written acknowledgment from the beneficiary or the beneficiary’s representative. Furthermore, the trust may limit the withdrawal right to the lesser of the amount of the annual gift tax exclusion or the fair market value of the property contributed to the trust.

Finally, the IRS may challenge arrangements that provide limited withdrawal rights without any other economic interest in the income or principal of the trust. These are sometimes referred to as “naked” Crummey powers. Accordingly, the IRS has ruled that the beneficiaries of a Crummey trust must have an actual economic interest in the trust property to meet the present interest requirement. (For example, the beneficiaries should have a vested right to principal or income.)