Crummey Trusts

‘Tis the Season for Gifting – Lifetime Gifts: An Important Estate Planning Technique (Part 1)

Prior to the substantial increase in the lifetime exemption amount, lifetime gift planning was a popular estate planning technique. In today’s estate tax environment, however, most advisors may not believe that such lifetime gift planning is required for most of their clients. But, estate planning techniques that involve making lifetime gifts, even today, are still very much alive. Some of these include the following: For those clients who –

May still be subject to the estate tax at death;
May want to engage in Medicaid planning;
May want to provide for their loved ones during their life; and
May want to decrease the size of their estate for easier estate administration after death.

Part 1 of this post will focus on a brief overview of the similarities and differences in making annual gifts as opposed to lifetime exemption gifts. Then, Part 2 of this post will focus on the above circumstances as to why someone may choose to make lifetime gifts even in today’s tax environment.

Annual Gifts

The annual gift exclusion is currently $14,000 per year for any and every recipient. This means that a taxpayer may give up to $14,000 per year to each and every person they wish. Furthermore, if the taxpayer is married, their spouse can consent to splitting the gift. This means that the married couple may give up to $28,000 per year to each and every person they wish.

A few important items to note regarding annual gifts include the following:

Any gift up to $14,000 (or $28,000 for a married couple) does not count towards your lifetime exemption amount. This means that you can give away up to the annual exclusion amount each year to as many people as you wish and never diminish your lifetime exemption amount.

Any gifts given up to the annual exclusion amount will be excluded from your estate. This means that they will not be counted as part of your estate after your death when determining whether or not you are subject to the estate tax.

Any appreciation on that gift will also be excluded from your estate. This means that if you gift a stock worth $100 to your child and, later, at the time of your death, the stock is now worth $150, not only will the $100 be excluded from your estate, but so will the $50 in appreciation ($150-$100).

Any gifts will have a carry-over basis to the recipient of the gift. This means that if you bought a stock at $100 and then, later, gift it to your child when it is worth $150, the child’s basis in the stock will be the same as yours, $100. This would result in $50 in capital gains subject to capital gains tax rates if your child were to later sell the stock ($150-$100).

Gifts may be made to either individuals or trusts (i.e., Crummey Trusts). It is important to note here that in order for the gift to be made to a trust for the benefit of someone, it must be a present, complete gift – see my previous blog post regarding Crummey Trusts. Also note, for example, that if you gift $14,000 to a Crummey Trust for the benefit of your child, you may not also use the annual exclusion amount to gift $14,000 outright to that same child in that same year. Whether the gift is given outright to your child or to a Crummey Trust for the benefit of your child or a combination of both, the maximum amount you can gift in 2014 is $14,000 to that child; that is, if you do not want to exceed the annual gift exclusion amount.

Any gifts made below or up to $14,000 do not require you to file an annual Gift Tax Return – Form 709. If the gift made to any one individual is greater than $14,000 in a single year, then a Gift Tax Return would be required to be filed.

If the annual exclusion amount for one year is not used, it does not carry over to the next year; if you don’t use it, you lose it. However, you will still be able to use that next year’s annual exclusion amount to make gifts.

Lifetime Exemption Gifts

The lifetime exemption amount in 2014 is $5.34 million ($5.43 million in 2015). This means that over and above the annual exclusion amount each year, you can gift up to $5.34 million during your lifetime without being subject to the gift tax. If you ever gift above this exemption amount during your lifetime, then you will be subject to a 40% gift tax. It is important to note that this is assessed against the gift giver; the one receiving the gift will not be subject to the gift tax (but may be later subject to the income tax or estate tax).

A few important items to note regarding lifetime exemption gifts include the following:

Gifts may be made to either individuals or trusts. Similar to annual gifts, you cannot exceed the lifetime exemption amount without being subject to the gift tax; how you spread out that exemption amount is completely up to you though. This means that you could give $2 mil to your daughter outright, $2 mil to your son outright, and $1.34 mil to a trust to be held for the benefit of your son and daughter. Also note that similar to annual gifts, special rules apply to trusts receiving gifts.

Any gifts made above the $14,000 annual exclusion amount (or $28,000 for a married couple) will count towards your lifetime exemption amount. This means that if in 2014 you give $114,000 to your child, $14,000 of the gift will be offset by the annual exclusion amount and $100,000 will offset your lifetime exemption amount, bringing that lifetime exemption amount down to $5.24 million.

Any gifts given will be excluded from your estate. However, any gifts given above the annual exclusion amount will be counted against your lifetime exemption amount at your death. This means that if in 2014 you gifted $5,354,000 to your child, $14,000 of the gift would be offset by the annual exclusion amount and $5.34 mil would offset your entire lifetime exemption amount but no gift tax would be assessed. However, when you later die, that $5.34 mil gift that offset your entire lifetime exemption in 2014 will also offset whatever the lifetime exemption amount is in the year of your death. Therefore, if you later died in 2015, you would only have $90,000 remaining for your lifetime exemption amount ($5.43 mil – $5.34 mil). Thus, any assets left in your estate at death above that $90,000 would be subject to the estate tax.

Any appreciation on that gift will be excluded from your estate and not count towards your lifetime exemption. This means that if you gift stock worth $5.34 mil to your child and use your entire lifetime exemption amount to do so tax-free and, later, at the time of your death, the stock is now worth $10.34 mil, only the $5.34 million will offset your lifetime exemption and the $5 mil in appreciation will not be included in your estate and will escape estate tax liability at your death.

Any gifts made will have a carry-over basis to the recipient of the gift. This means that if you bought stock at $1 mil and then, later, gift it to your child when it is worth $1.5 mil, the child’s basis in the stock will be the same as yours, $1 mil. This would result in $0.5 mil in capital gains subject to capital gains tax rates if your child were to later sell the stock ($1.5 mil -$1 mil).

Any gifts made above the $14,000 annual exclusion to any one person will require you to file an annual Gift Tax Return – Form 709. However, no tax will be due as long as you have not used up your entire lifetime exemption amount.

The lifetime exemption amount is just that, a lifetime exemption. Once it is used up, it is gone. However, under the current law, it increases each year (i.e., it is indexed for inflation). This means that if in 2014 you used up the entire $5.34 mil lifetime exemption, in 2015 you would receive another $90,000 in lifetime exemption because of the increase to $5.43 mil.

When you die, if you have not used up your entire lifetime exemption amount, your surviving spouse may elect to “port” your lifetime exemption amount. This means that if you die with $5.34 mil of unused lifetime exemption (i.e., your entire estate goes to your surviving spouse so that you don’t have to use any of your exemption), and your surviving spouse ports your lifetime exemption, the surviving spouse’s lifetime exemption in 2014 would then be $10.68 mil ($5.34 mil + $5.34 mil). Note that there are many different rules and strategies as to why a couple may or may not use portability, which will be discussed in a later blog post.

Conclusion

As you can see from the summary discussion above, there are many similarities, differences and little quirks to consider before making annual gifts and lifetime exemption gifts. Part 2 of this post will focus on some of those considerations and the different circumstances in which you may still want to consider and advise your clients to make lifetime gifts, even in today’s tax environment.

Happy Holidays!

-Matt

The Monthly 5 and 5: The 5 or 5 Power

Each month I will be publishing a post discussing five advantages and five disadvantages of a particular estate planning technique – the post will be called The Monthly 5 and 5. In this first installment of The Monthly 5 and 5, I will be discussing the “5 or 5 power.” Notice the similarity? Yes, that’s right, the “5 or 5 power” was inspiration for The Monthly 5 and 5.

The “5 or 5 power” gives a beneficiary of a trust the power in any calendar year to withdraw the greater of $5,000 or 5% of the trust’s assets. This means that for any trust with assets of less than $100,000, the beneficiary will have the power to withdraw up to $5,000 each year; and, for any trust with assets of more than $100,000, the beneficiary will have the power to withdraw up to 5% of the value of the trust’s assets each year (i.e., because 5% of $100,000 is $5,000).

You may be asking yourself: Why $5,000 or 5%? What’s so magical about those numbers? Well, put most simplistically, because that is what the Internal Revenue Code (IRC) says. In order to avoid certain consequences, this annual withdrawal power is limited to $5,000 or 5% of the trust’s assets under the IRC. Why is it important to abide by the IRC? Well, for instance, if instead, you gave the beneficiary more than a $5,000 or 5% annual power to withdraw, the beneficiary’s withdrawal power could be deemed a general power of appointment over the trust and some or all the assets in the trust could be included in the beneficiary’s estate for estate tax purposes. This could create devastating tax consequences for the beneficiary.

Below are five reasons (each with an advantage and disadvantage) why the “5 or 5 power” can be a useful estate planning tool:

Reason 1: Minimum Distribution

Let’s say that the trust allows the trustee to only distribute the income of the trust (and not any of the trust principal) to the beneficiary each year for the beneficiary’s support. If in a particular year the trust generates very little income, the 5 or 5 power allows the beneficiary the power to withdraw up to $5,000 or 5% of the trust’s assets that year regardless of the amount of trust income.

Advantage: At a minimum, the beneficiary will be able to receive at least $5,000 per year for support.

Disadvantage: The amount subject to the beneficiary’s 5 or 5 power may not be protected from the beneficiary and/or creditors of the beneficiary.

Reason 2: Strict Trustee

Let’s say that the trust allows the trustee to distribute income and/or principal only for the health, education and support of the beneficiary. If a trustee is particularly strict when following this standard and distributes very little to the beneficiary, the 5 or 5 power allows the beneficiary the power to withdraw up to $5,000 or 5% of the trust’s assets each year even if it is not for the health, education and support of the beneficiary.

Advantage: The beneficiary will be able to withdraw at least up to $5,000 per year without having to satisfy the trustee that it is being used for health, education and support.

Disadvantage: The beneficiary could exhaust the trust more rapidly than intended over time, whether the trust is small (i.e., $5,000 withdrawn each year) or large (5% of trust assets are withdrawn each year), when the main purpose of the trust may have been to transfer wealth to future generations.

Reason 3: Benefit Without Estate Inclusion

Let’s say that both the trust grantor and his wife are near their lifetime exemption amounts for estate taxes (i.e., if they go over their exemption amount, part of their estate will be subject to estate taxes). The trust grantor sets up a trust for the benefit of his spouse during her lifetime with the remainder going to his children at his wife’s death. Here, the 5 or 5 power allows the wife to use the trust as another source of support and income during her lifetime (limited to $5,000 or 5%) but does not substantially increase her estate for estate tax purposes at her death.

Advantage: The amount of trust assets not subject to the 5 or 5 power are not included in the wife’s estate at her death; and, thus, not subject to estate taxes at her death.

Disadvantage: The amount of trust assets subject to the 5 or 5 power (i.e., the greater of $5,000 or 5% of the trust’s assets) will be included in the wife’s estate at her death; and, thus, if including this amount in her estate causes her total estate to exceed her lifetime exemption amount, the amount that exceeds the lifetime exemption amount will be subject to estate taxes at her death.

Reason 4: Crummey Trusts

Let’s say that the trust grantor set up a Crummey Trust for his two children. Each year his two children allow their right to withdraw the amount of the annual gift to lapse. When a beneficiary allows their withdrawal right to lapse, it is considered a deemed gift to the other beneficiaries of the trust. However, by adding the 5 or 5 power to the Crummey Trust, the lapsing of the withdrawal right is only considered a deemed gift to the other beneficiaries so much as it exceeds $5,000 or 5% of the trust’s assets.

Advantage: If the amount of the annual gift to the Crummey Trust is less than or equal to $5,000 or 5% of the trust’s assets, there will be no deemed gifts to the other beneficiaries by allowing the withdrawal right to lapse.

Disadvantage: While the main purpose of a Crummey Trust is to protect the trust assets from the beneficiaries until you see fit (as spelled out in the trust document), the 5 or 5 power gives the beneficiaries unfettered rights to withdraw up to $5,000 or 5% of the trust’s assets each year, regardless of the amount of the current year’s gift.

Reason 5: Hanging Crummey Trusts

Let’s use the same scenario as in Reason 4 except that the amount of the annual gift exceeds $5,000 or 5% of the trust’s assets. If the amount of the gift exceeds $5,000 or 5% of the trust’s assets, it is considered a deemed gift to the other beneficiaries of the amount in excess of the 5 or 5 power; and, thus, possibly causing gift tax consequences for the beneficiaries in the future. However, by adding a “hanging Crummey” provision, the amount of this deemed gift can be eliminated over time (I will explain this further in another post).

Advantage: Over time, the amount of any deemed gift to the other beneficiaries caused by allowing the withdrawal right to lapse will be eliminated; thus, not creating gift tax consequences for the beneficiaries in the future.

Disadvantage: The “hanging Crummey” provision allows the beneficiary to have continued withdrawal rights over the accumulated amount of gifts that have not yet been offset by the 5 or 5 power; thus, allowing such withdrawal rights to possibly substantially increase over time, contrary to what the trust grantor may have intended.

As you can see above, adding a “5 or 5 power” to a trust document may be done for a number of reasons and it does have some really important advantages. But, like most things in life, the advantages must be weighed against the disadvantages. As always, if a “5 or 5 power” is something you are considering, you should consult an experienced estate planning attorney. It will be each individual’s personal situation and wishes that will control whether or not the advantages outweigh the disadvantages of utilizing a “5 or 5 power” in their estate planning.

– Attorney Matthew D. Brehmer

“Crummey Estate Plan”…Why “Crummey”?

As you can see, the name of this blog is “Crummey Estate Plan.” If you’re not an estate planning attorney, CPA or financial advisor, or even if you are, you may be a bit confused as to why I would pick such a name. Well, it was my attempt at trying to be funny. And, the fact that I now have to explain the “play on words” makes the already not-so-funny name, not funny and most likely pretty lame. However, my hope is that if you don’t get it, this article will educate you enough so that one day in the future you will look back at the name of this blog and at least give it a “ha, ha, that is pretty clever” – I can dream, right?

First and foremost, I can spell. I know that “Crummey” in the traditional sense of the word is spelled “crummy.” In this blog, it is spelled “Crummey” after an important gift tax and estate planning case, Crummey v. Commissioner, 397 F.2d 82 (9^th Cir. 1968); but, more on that later. The main purpose of this blog is to provide estate planning attorneys, CPAs, financial advisors and anyone else interested in estate planning with foundational concepts, advantages & disadvantages, tips and new developments on different estate planning techniques. By doing so, my hope is that there will be less “crummy” estate planning going on.

But, naming a blog “Crummy Estate Plan” would be no fun. That is why, as you will find out below, naming my blog “Crummey Estate Plan” was genius (well, maybe not genius, but clever?). The name creates a “play on words” while also introducing an important estate planning technique that uses what are called “Crummey Trusts.”

Let’s first set up a typical situation where a Crummy Trust may be advantageous. The individual is already or plans on making annual gifts to their children, grandchildren, or other loved ones. Here, let’s say the grandmother wants to make annual gifts to her grandchildren. There could be a variety of reasons for this – it’s a way to decrease the size of her estate, to transfer wealth to her family members, etc. Multiple posts could be written on the different reasons why making annual gifts during your lifetime may be an extremely important and beneficial estate planning technique but let’s keep this simple and save that for later blog posts. For purposes of this post, let’s just say that the grandmother is making annual gifts to her grandchildren and not worry about why.

Like in most scenarios, the grandmother may not want to make the gifts outright to her grandchildren. Again, this could be for a number of reasons – impending divorce or bankruptcy, they are too young to be responsible with the money, the grandmother wants them to save it, etc. One a way to protect this gift is to put it in a trust for the benefit of her grandchildren. This will provide the protection the grandmother wants. Easy enough, right?

Wait, not so fast. In order for the gift to qualify and be used to offset the grandmother’s annual gift exclusion amount and not her lifetime exemption amount, the gift has to be a present gift and not a future gift. In 2014, the annual gift exclusion amount is $14,000. This means that a taxpayer may give up to a $14,000 gift to any and all persons in 2014 with no resulting tax effects or consequences. The reason why the grandmother will want to use the annual gift exclusion amount instead of her lifetime exemption amount is so that she can save that lifetime exemption amount for future estate planning (again, let’s save this for another post).

If the grandmother puts the gift in an everyday ordinary trust for her grandchildren that does not allow them to access it until they are age 25, then that is not a present gift, that is a future gift. In order for the gift to be a present gift and be offset by the annual gift exclusion, the grandchildren have to have the right to access it on the day of the gift. You are probably thinking, well if the trust allows for that, that will defeat the grandmother’s whole purpose of setting up the trust to protect the gift and she might as well just give them the gift outright. Well, herein lays the importance of a Crummey Trust.

The Crummey Trust allows the grandmother to make gifts to a trust in an amount up to the annual gift exclusion amount, while also protecting the gift and providing instruction and guidance as to how it should be used by or for her grandchildren in the future. The court in Crummey v. Commissioner confirmed that such a trust allows the taxpayer to use its annual gift exclusion to fund the trust with gifts while also transferring the amount of the gifts out of their estate (which can be very important and beneficial for wealthy taxpayers who may be subject to estate taxes when they pass away).

Perfect! Now, how does one create such a trust? Well, you need to consult an experienced estate planning attorney who has experience drafting Crummey Trusts to make sure it is set up and administered correctly. If done incorrectly, the tax consequences could be devastating and the gifting to the trust may not achieve what you had intended (i.e., to protect the gift and provide instruction and guidance as to its future use).

The basic idea is this though: The trust document must give the beneficiary (or, here, the grandmother’s grandchildren) the power to demand immediate possession and enjoyment of the gift. This satisfies the “present gift” requirement so that the grandmother can use her annual gift exclusion amount to offset the gift and the gift will no longer be a part of her estate. However, the grandchildren’s power to demand immediate possession and enjoyment of the gift is not unlimited. While the trustee must give each grandchild an annual written notice of their right to withdraw from the trust (typically called “Crummey Letters”), the period of time in which the grandchild may withdraw such gift is limited. The period of time is typically 30 days.

If the grandchildren decide not to exercise their right to immediate possession and withdraw the gift, then the gift will become part of the trust’s principal and be subject to the trust’s distribution limitations (such limitations could include that the trust assets can only to be used for support, health and education of the grandchildren or that a grandchild does not receive their share of the trust until they turn age 25, etc.). Typically, a beneficiary will not exercise their right to immediate possession; therefore, all of the grandmother’s intentions will be carried out – the gift qualifies for the annual exclusion, is excluded from her estate and is held in trust, which provides protection of the gift and controls the ultimate distribution of the gift.

Some of us may not understand why the grandchildren would not exercise their right to immediate possession of the gift, I mean who wouldn’t? Just a thought, but it is probably because they fear (or know) that if they do, they will jeopardize any future gifts that their grandmother may have planned to make to them in the future (i.e., grandmother will stop making the gifts). And, even if certain grandchildren were to exercise that right in a particular year, they only have access to the amount of that year’s gift, not to any previous gifts already a part of the trust’s principal.

There you go, that’s a Crummey Trust. Get the “play on words” now? Clever, right? My hope is that this post taught you some of the foundational concepts for a Crummey Trust. And, as always, if this is something you are considering for yourself or considering to use in your practice, consult an experienced estate planning attorney first. And, to keep you hungry for more, another use for Crummey Trusts is to protect life insurance from federal estate taxes, but I will leave that strategy for another post in the future.

– Attorney Matthew D. Brehmer