Once upon a time, there was an estate planner who had a stroke of marketing brilliance. He or she decided that we should call "death insurance" "life insurance" instead! Since that time, estate planners haven't had a similar Mad Men-type moment. For example, they tell people they should employ the deceptively sounding "crummy" trusts (a.k.a. Crummey Trusts, named after D. Clifford Crummey). In 1968, Mr. Crummey won a decision in the Ninth Circuit. Proving its lack of crumminess, Mr. & Mrs. Israel and Erna Mikel were just in U.S. Tax Court showing how powerful the Crummey power can be, as they sheltered (from gift tax) over $1.4 million in transfers to their family trust. An arbitration clause within that called for the use of a religious court caused the IRS to challenge the validity of the exclusions, but the Tax Court ruled in the Mikel’s favor.
A recent Forbes article, titled “Religious Arbitration Clause Does Not Hurt Million Plus Gift Tax Exclusion,” reminds us that there’s an annual exclusion from gift tax. Reminder: every year you can give the annual exclusion amount ($14,000 this year) to as many people as you want without any gift taxes or disturbing the unified credit against transfer taxes. However, to qualify for the exclusion, the gift has to be of a “present interest”.
When you make gifts to the kids and grandkids, you don’t want to hand them cash at that very moment, do you? Likely, you want the money in the hands of a trustee who will distribute it to them responsibly. This stuff is admittedly a bit technical, but that’s about the exact opposite of a “present interest,” which can be problematic.
The article explains that the Crummey power is a way around this problem. Money or property goes into the trust and the trustee is directed to notify the beneficiaries who get a short time to withdraw up to the annual exclusion amount. However, beneficiaries are discouraged from doing this, and it’s rarely done. But people worry about this and oftentimes put provisions in their trusts to discourage the beneficiaries from withdrawing the assets.
In the case of Israel and Erna Mikel, each made gifts to a family trust with an “asserted value” of $1.6M, and each claimed annual exclusions of $720,000. The annual exclusion in 2007 was $12,000, so if you do the math, it means 60 people had withdrawal rights. According to the court decision, they were all lineal descendants or spouses of descendants. The IRS disallowed the exclusions claiming that the beneficiaries lacked legally enforceable rights to withdraw the funds.
Once the Crummey power lapsed, there was no guarantee that any beneficiary would get anything from the trust. The trust provided that any disputes concerning the interpretation of its terms would be submitted before a “Beth Din” panel, which consists of three persons of the Orthodox Jewish faith. Along the same lines, there’s another trust provision which states that if a beneficiary litigates a distribution of the trust, the squeaky wheel’s interest will be revoked. This is called an “in terrorem” clause. With all these restrictions, the IRS argued that the withdrawal rights were not “legally enforceable.”
The Tax Court believed that the “in terrorem” clause was much more limited and was there to emphasize the trustee’s broad discretion to make distributions. It would only be triggered if a beneficiary brought a suit that challenged an actual distribution to another beneficiary. As a result, the beneficiary did have an enforceable right to demand a distribution during the Crummey window (even though beneficiaries never do that in practice).
An experienced estate planning attorney can explain this in greater detail.
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Reference: Forbes (May 11, 2015) “Religious Arbitration Clause Does Not Hurt Million Plus Gift Tax Exclusion”