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2017 Estate and Gift Tax Update – A Quick Snapshot

Every year I like to post a quick Estate and Gift Tax update for you to reference throughout the year. This way, if you’re anything like me, you won’t find yourself constantly “Googling” different estate and gift tax thresholds at the beginning of the year for a quick refresher on the updated thresholds. The purpose of this post is to provide a snapshot of some of the most common 2017 estate and gift tax thresholds, tax rates, exemptions, elections, etc. Feel free to use this how you see fit. Additionally, if you have any other commonly used 2017 estate and/or gift tax updates that I may have left off the list, please feel free to leave them in the comments.

Federal Gift Tax

  • Lifetime Exemption: $5,490,000
  • Annual Exclusion: $14,000
  • Gift-Splitting: Yes, if married and spouse consents (i.e., annual exclusion is $28,000 for married couples)
  • Rate: 40% on gifts above the lifetime exemption (plus the annual exclusion)

Federal Generation-Skipping Transfer Tax

  • Exemption: $5,490,000
  • Portability: No
  • Rate: 40% on generation-skipping transfers above the exemption

Federal Estate Tax

  • Exemption: $5,490,000 (exemption is decreased by lifetime gifts)
  • Portability: Yes (i.e., surviving spouse may elect to use deceased spouse’s unused exemption, in effect, giving married couples an exemption of $10,980,000)
  • Rate: 40% on the value of the estate above the exemption amount

Federal Income Tax for Trusts and Estates

  • Tax Brackets: see chart below
  • Tax Rates: see chart below
  • Net Investment Income Tax: A 3.8% surcharge tax on net investment income applies to trusts and estates that are above the $12,500 income threshold (i.e., the marginal tax rate on net investment income above that threshold is then 43.4%)
  • Distributable Net Income: Net income that is distributed to beneficiaries of a trust or estate is taxed at the beneficiaries’ level and not at the trust or estate’s level
Chart: Federal Income Taxation of Trusts and Estates
If Taxable Income is: The Tax is:
Not over $2,550 15% of the taxable income
Over $2,550 but not over $6,000 $382.50 plus 25% of the excess over $2,550
Over $6,000 but not over $9,150 $1,245.00 plus 28% of the excess over $6,000
Over $9,150 but not over $12,500 $2,127.00 plus 33% of the excess over $9,150
Over $12,500 $3,232.50 plus 39.6% of the excess over $12,500


State Taxes

Each State has its own set of rules when it comes to estate tax, gift tax, inheritance tax, and income taxation of trusts and estates. Be sure to check with a professional in your State for an update.

For a complete summary of all 2017 Federal tax-related inflation adjustments see Rev. Proc. 2016-55, available here: https://www.irs.gov/pub/irs-drop/rp-16-55.pdf.

I hope this helps!

-Matt

 

© 2016 Matthew D. Brehmer and Crummey Estate Plan.

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2016 Estate and Gift Tax Update – A Quick Snapshot

Last year it dawned on me that a lot of us out there, including myself, find ourselves constantly “Googleing” different estate and gift tax thresholds throughout the beginning of the year for a quick refresher on the updated thresholds. The purpose of this post is to provide a snapshot of some of the most common 2016 estate and gift tax thresholds, tax rates, exemptions, elections, etc. Feel free to use this how you see fit. Additionally, if you have any other commonly used 2016 estate and/or gift tax updates that I may have left off the list, please feel free to leave them in the comments.

Federal Gift Tax

  • Lifetime Exemption: $5,450,000
  • Annual Exclusion: $14,000
  • Gift-Splitting: Yes, if married and spouse consents (i.e., annual exclusion is $28,000 for married couples)
  • Rate: 40% on gifts above the lifetime exemption (plus the annual exclusion)

Federal Generation-Skipping Transfer Tax

  • Exemption: $5,450,000
  • Portability: No
  • Rate: 40% on generation-skipping transfers above the exemption

Federal Estate Tax

  • Exemption: $5,450,000 (exemption is decreased by lifetime gifts)
  • Portability: Yes (i.e., surviving spouse may elect to use deceased spouse’s unused exemption, in effect, giving married couples an exemption of $10,900,000)
  • Rate: 40% on the value of the estate above the exemption amount

Federal Income Tax for Trusts and Estates

  • Tax Brackets: see chart below
  • Tax Rates: see chart below
  • Net Investment Income Tax: A 3.8% surcharge tax on net investment income applies to trusts and estates that are above the $12,300 income threshold (i.e., the marginal tax rate on net investment income above that threshold is then 43.4%)
  • Distributable Net Income: Net income that is distributed to beneficiaries of a trust or estate is taxed at the beneficiaries’ level and not at the trust or estate’s level
Chart: Federal Income Taxation of Trusts and Estates
If Taxable Income is: The Tax is:
Not over $2,550 15% of the taxable income
Over $2,550 but not over $5,950 $382.50 plus 25% of the excess over $2,550
Over $5,950 but not over $9,050 $1,232.50 plus 28% of the excess over $5,950
Over $9,050 but not over $12,400 $2,100.50 plus 33% of the excess over $9,050
Over $12,400 $3,206 plus 39.6% of the excess over $12,400

State Taxes

Each State has its own set of rules when it comes to estate tax, gift tax, inheritance tax, and income taxation of trusts and estates. Be sure to check with a professional in your State for an update.

For a complete summary of all 2016 Federal tax-related inflation adjustments see Rev. Proc. 2015-53, available here: https://www.irs.gov/pub/irs-drop/rp-15-53.pdf.

I hope this helps!

-Matt

 

© 2015 Matthew D. Brehmer and Crummey Estate Plan.

2015 Estate and Gift Tax Update – A Quick Snapshot

It recently dawned on me that a lot of us out there, including myself, find ourselves constantly “Googleing” different estate and gift tax thresholds throughout the beginning of the year for a quick refresher on the updated thresholds. The purpose of this post is to provide a snapshot of some of the most common 2015 estate and gift tax thresholds, tax rates, exemptions, elections, etc. Feel free to use this how you see fit. Additionally, if you have any other commonly used 2015 estate and/or gift tax updates that I may have left off the list, feel free to leave them in the comments.

Federal Gift Tax

  • Lifetime Exemption: $5,430,000
  • Annual Exclusion: $14,000
  • Gift-Splitting: Yes, if married and spouse consents (i.e., annual exclusion is $28,000 for married couples)
  • Rate: 40% on gifts above the lifetime exemption (plus the annual exclusion)

Federal Generation-Skipping Transfer Tax

  • Exemption: $5,430,000
  • Portability: No
  • Rate: 40% on generation-skipping transfers above the exemption

Federal Estate Tax

  • Exemption: $5,430,000 (exemption is decreased by lifetime gifts)
  • Portability: Yes (i.e., surviving spouse may elect to use deceased spouse’s unused exemption, in effect, giving married couples an exemption of $10,860,000)
  • Rate: 40% on the value of the estate above the exemption amount

Federal Income Tax for Trusts and Estates

  • Tax Brackets: see chart below
  • Tax Rates: see chart below
  • Net Investment Income Tax: A 3.8% surcharge tax on net investment income applies to trusts and estates that are above the $12,300 income threshold (i.e., the marginal tax rate on net investment income above that threshold is then 43.4%)
  • Distributable Net Income: Net income that is distributed to beneficiaries of a trust or estate is taxed at the beneficiaries’ level and not at the trust or estate’s level

Chart: Federal Income Taxation of Trusts and Estates

If Taxable Income is: The Tax is:
Not over $2,500 15% of the taxable income
Over $2,500 but not over $5,900 $375 plus 25% of the excess over $2,500
Over $5,900 but not over $9,050 $1,225 plus 28% of the excess over $5,900
Over $9,050 but not over $12,300 $2,107 plus 33% of the excess over $9,050
Over $12,300 $3,179.50 plus 39.6% of the excess over $12,300

State Taxes

Each State has its own set of rules when it comes to estate tax, gift tax, inheritance tax, and income taxation of trusts and estates. Be sure to check with a professional in your State for an update.

For a complete summary of all 2015 Federal tax-related inflation adjustments see Rev. Proc. 2014-61, available here: http://www.irs.gov/pub/irs-drop/rp-14-61.pdf

I hope this helps!

-Matt

© 2015 Matthew D. Brehmer and Crummey Estate Plan.

Lifetime Gifts: An Important Estate Planning Technique (Part 2)

In Part 1 of this post, I focused on the similarities and differences between making annual gifts and making lifetime exemption gifts. Here, in Part 2 of this post, I will focus on the following reasons why it may still be important to consider making lifetime gifts:  

  • To minimize estate taxes;
  • To engage in Medicaid planning;
  • To provide for your loved ones during your lifetime; and
  • To decrease the size of your estate for easier estate administration after your death.

Minimize Estate Tax

Currently, in 2015, the estate tax exemption amount is $5.43 million. That combined with your spouse’s lifetime exemption amount if you are married, comes to $10.86 million. Therefore, for a vast majority of the population, minimizing estate tax is not even going to be on the radar. However, even though this exemption is permanent and indexed for inflation currently (and has been since 2010), Congress could always repeal it and lower the exemption amount; for instance, just seven years ago the exemption was only $2 million and if you look back another ten years before that, it was only $625,000. If Congress chose to go back to the “good old days,” a lot more of us would be subject to the estate tax. Keep that in mind.

For those of you who are unlucky enough (or, maybe I should say lucky enough) to be above the estate tax exemption, lifetime gifting is a great strategy to minimize estate taxes. Basically, by gifting assets away during your lifetime, either through annual gifts or lifetime exemption gifts, you are in essence “freezing” part of your estate. Consider the two following examples:

Example 1: You and your spouse have a $20 million estate today. You both live another 20 years, during which time your estate earns 6% annual interest and is now valued at about $64 million. Assuming the estate tax exemption increases at 3% during that same time, your combined estate tax exemption amount is about $19.5 million. Therefore, about $44.5 million of your estate will be subject to estate tax, which comes to about $17.8 million in estate taxes (at a 40% estate tax rate).

Example 2: You and your spouse have a $20 million estate today. Using $10 million of your combined estate tax exemption amount, you make a lifetime gift of $10 million, bringing the value of your estate down to $10 million. Assuming the same 6% interest, after 20 years, your estate is now worth about $32 million. And, assuming the same estate tax exemption amount as in Example 1 (about $19.5 million twenty years from now), you would have about $9.5 million of combined estate tax exemption left to use ($19.5 million – $10 million previously used). Therefore, about $22.5 million of you estate will be subject to estate tax, which comes to about $9 million in estate taxes.

As you can see from the two examples above, by making a lifetime gift, you can save a substantial amount in estate taxes; $8.8 million in the examples above. Furthermore, the two examples above are stripped down for ease of illustration; if you took annual gifts into account each year and also used up the increase in the lifetime exemption amount each year, the savings would be even more substantial (plus there are many other strategies that can make lifetime gifting even more effective, e.g., by applying discounts to certain assets when gifting).

The main reason why this works so well is because your estate is typically going to grow at a faster rate than the estate tax exemption amount (and the greater the arbitrage, the greater the effect lifetime gifting can have on your eventual estate tax liability). Basically, meaning that, when you make a lifetime gift and rid your estate of that asset, you also rid your estate of the accumulation that the asset is going to make over your remaining lifetime. So you are in effect, freezing the value of that asset and the amount of your lifetime exemption that it is going to offset.

However, there is one major caveat to consider here and when considering any other reason to make lifetime gifts. When you die with an asset in your estate, the asset receives a step-up in basis. When you gift an asset during your lifetime, the asset has a carry-over basis. Below are two examples that illustrate the difference:

Example 1: Years ago you bought an asset for $10. It is now worth $100. The day before you die you gift it to your child. Your child then receives a carry-over basis of $10. If your child were to sell that asset when it is worth $110, your child would be subject to long-term capital gains tax on $100 ($110 – $10).

Example 2: Years ago you bought an asset for $10. It is now worth $100. You die with the asset and bequest it to your child. Your child then receives a step-up in basis of $100. If your child were to sell that asset when it is worth $110, your child would be subject to long-term capital gains tax on only $10 ($110 – $100).

As you can imagine, that difference plays a major role when considering lifetime gifting. In some instances, it may be a deal breaker, and in others, it may not affect the decision as much. For instance, if you will be subject to estate taxes, it may be more beneficial to reduce your estate before you die even if your child would be subject to more capital gains tax on that asset because the highest long-term capital gains tax rate is only 23.8% (which includes the net investment income tax) compared to a 40% estate tax rate. However, if you are not subject to the estate tax, it may be more beneficial to keep low basis and high growth assets in your estate so that when you pass away, those assets will receive a step-up in basis and save your heirs substantial amounts in long-term capital gains tax.

Medicaid Planning

Nursing home costs are a major concern for many (and, with good reason, the national average nursing home costs are around $6,500 a month).  Long-term nursing home care can wipe out your entire estate pretty quickly. Therefore, Medicaid planning has become a large part of estate planning today. And, one of the most used Medicaid planning strategies is lifetime gifting.

Each State has its own complex set of rules when it comes to Medicaid planning with lifetime gifting and the rules are forever changing so it is important to contact an expert when considering this strategy. However, the basic strategy is this – to gift away your assets prior to the Medicaid look back period (depending on your State that look back period could be 3 years, 5 years, or some other time period).

There are a number of risks associated with lifetime gifting that are especially pertinent here. Once you’ve made a gift it is irrevocable. Meaning that the person you gave the gift to now owns it. You cannot get it back. Furthermore, the person who you gave the gift to is now at risk of losing it; for example, to creditors, to a divorcing spouse, to different heirs if they pass away, etc. This means that the person you gave the gift to may not be able to support you later on should you need it.

All of these risks are heightened during Medicaid planning. This is because if you don’t make it past the look back period, you will be hit with a penalty period based on the gifts given during that look back period. During that penalty period you will not receive support from Medicaid for nursing home costs, which could really leave you in a tough spot if you have no other access to support. Furthermore, if you never end up needing Medicaid and living a long life outside of a nursing home (like we all hope), you may no longer have enough to support yourself because you gifted it all away. Therefore, lifetime gifting as a Medicaid planning technique must be discussed with an expert to ensure you are weighing all of the benefits and risks associated with it.

Providing for Loved Ones During Life

Lifetime gifting may be a great way to provide for your loved ones during your lifetime. If an annual gift is less than $14,000 to any one person, not only will there be no tax liability, there is no requirement to file a Gift Tax Return. Even if the gift is greater than $14,000, there will be no tax liability so long as you have not used up your entire current lifetime exemption amount of $5.43 million. However, you will be required to file a Gift Tax Return to report a gift greater than $14,000 to any one person within the same year.

Lifetime gifts can be a great way for people to support their loved ones during their lifetimes without the fear of tax consequences or added responsibilities (like filing another tax return). However, you do need to consider the carry-over basis versus step-up in basis discussion above if gifting securities and/or property as opposed to cash.

Ease of Estate Administration at Death

Lifetime gifting may also be a great way to ease the administration of your estate at the time of your death. Typically, the smaller the estate, the easier it is to administer it at death. Furthermore, the type of assets that are held in your estate at the time of your death can determine how easy or how cumbersome administering your estate will be. If your estate is made up of entirely nonprobate assets, then administering your estate will be relatively easy. However, if you estate is made up of many different probate assets, then administering your estate will become more cumbersome and expensive.

By making lifetime gifts that reduce the value of your estate and rid your estate of probate assets, you can really lift some of the burden and costs that fall on your loved ones when having to administer your estate after your death. Again, however, you do need to consider the carry-over basis versus step-up in basis discussion above. Furthermore, you do not want to diminish your estate to a level where it becomes difficult for you to live day-to-day.

Conclusion

As you can see from above, lifetime gift planning is still very much alive in estate planning today. And, this holds true even for those who are not concerned about estate taxes. However, there are many things that need to be considered before making a lifetime gift and they should be discussed with an expert. But, if after weighing all of the risks and benefits, the scales are tipped in your favor, lifetime gifting can provide an important estate planning technique that starts to take effect prior to much of your other estate planning.

Thanks for reading!

-Matt

© 2015 Matthew D. Brehmer and Crummey Estate Plan.

‘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

© 2014 Matthew D. Brehmer and Crummey Estate Plan.

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

 

© 2014 Matthew D. Brehmer and Crummey Estate Plan.