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New WTP Form: ExtraCrummeyTrust(sm)1: It May Be the Best Annual Exclusion Vehicle Around
By Jonathan G. Blattmachr and Michael L.
Graham.
© 2007. All Rights Reserved.
Introduction
In this article, we discuss a concept called the "ExtraCrummeyTrust(sm)",
a new, separate form of trust being introduced in Wealth Transfer Planning for 2007. It is a variation of the Crummey Trust, one of the most widely
used vehicles in estate planning. Like the Crummey Trust, powers of withdrawal granted to beneficiaries permit contributions to qualify for the gift tax annual exclusion under Sec. 2503(a) of the Internal Revenue
Code ("Code"). Unlike the Crummey Trust, the ExtraCrummeyTrust(sm) allows transfers to qualify for the
generation-skipping transfer tax ("GST") annual exclusion under Code Sec. 2642(c) of the Code when transfers are made for the benefit of grandchildren, more remote descendants or other
"skip persons," defined in Code Sec. 2613(a) of the Code. In other words, it does something "extra."
Before describing the ExtraCrummeyTrust(sm) in detail, we
discuss certain matters relating to the annual exclusion including making transfers for minors through a trust described in Code Sec. 2503(c) of the Code (a "Section 2503(c) Trust") and
under the Uniform Transfers to Minors Act ) ("UTMA").
The Lowdown on Benefits of Annual Exclusion Gifts
The gift tax annual exclusion allowed under Code Sec. 2503(a)
represents a powerful lifetime estate planning tool. Depending upon whether (i) the property owner is married (and, if so, whether his or her
spouse will gift split pursuant to Code Sec.2513 of the Code), (ii) the number of potential donees (e.g., descendants) that a property owner wishes to benefit and (iii) the period over which
the annual exclusion gifts are made, there is the potential of removing millions of dollars from his or her gross estate, entirety free of gift tax. For
example, a couple which gives $24,000 per year to their three children and six grandchildren each year for 20 years in a manner which qualifies for the annual exclusion, will have removed over
$4 million from their estate (even without considering appreciation and income earned on the gift property). If the property grew at 8% a year this
would result in over $10 million being excluded from their estates. (And, because the amount of the annual exclusion is adjusted for inflation
pursuant to Code Sec.2503(b)(2) of the Code, it is likely that even more than indicated would be removed from the gross estate.
Transfers Qualifying for the Gift Tax Annual Exclusion
Each individual may make a gift of up to $12,000
a year to each of as many recipients as the donor wishes and these gifts will be completely gift tax free under the protection of the gift tax annual exclusion. However, the annual exclusion is allowed only for gifts of a present interest and not for gifts of a future interest. (Present interests are
defined in Treas. Reg. § 25.2503-3.) Outright transfers almost certainly will qualify for the gift
tax annual exclusion under Code Sec. 2503(b). Property owners, however, often do not want people of young ages (as their children and grandchildren may be) to receive ownership of property directly, preferring instead for the
ownership to be deferred until the grandchild reaches a more mature age or certain needs arise, such as college education. Although transfers to
trusts usually do not qualify for the annual exclusion, there are certain trust or trust equivalents, transfers to which may qualify in full for the annual exclusion. Three common techniques used to capture the benefit of the annual exclusion while avoiding direct ownership by the donee are transfers (1) under the Uniform Gifts to
Minors Act, if the donee is a minor, (2) to a trust described in Code Sec. 2503(c), if the donee is under age 21 years, and (3) to a trust under which the donee holds a so-called
"Crummey" power of withdrawal, regardless of the donee's age. (The name "Crummey Power" or "Crummey Trust" is derived from Commissioner
v. Crummey, 397 F.2d 82 (9th Cir. 1968), in which it was held that a currently exercisable although annually lapsing power of withdrawal held by a minor qualified transfers to a
trust for the gift tax annual exclusion to the extent the power could be exercised.)
Annual Exclusion Gifts to Minors
An outright gift to a minor probably cannot be made (on account of
the minor's legal incapacity to accept a gift). Therefore it may be that such a gift cannot qualify for the annual exclusion unless the minor has
a guardian of the property who accepts the gift for the minor. Guardianships, however, are so restrictive and expensive that they are rarely, if ever, used as the vehicle by which annual exclusion gifts are made to a minor.
As indicated, transfers to certain trusts or similar vehicles may
qualify for the annual exclusion despite the fact that, in general, transfers to trust qualify for the exclusion only in part or not at all. See,
e.g., Examples under Reg. § 25.2503-3(c). The Section 2503(c) Trust is type of trust that qualified for the annual exclusion but only if it is
created for someone under the age of 21 years and only with respect to gifts made while he or she is under that age. The terms of the trust
are somewhat restrictive. Many clients express dissatisfaction with the perceived limitation that the trust must either end when the
beneficiary reaches 21 years of age or the beneficiary must have the right to terminate it at that time for at least a brief period. See
Rev. Rul. 74-43, 1974-1 CB 285.
An alternative to a transfer to a Section 2503(c) Trust is one to a
UTMA account. Transfers to a custodian (the title of the fiduciary who holds the property for the minor under the UTMA arrangement) are treated as gift to the minor and qualify for the annual
exclusion. And, according to the IRS, they so qualify under Code Sec. 2503(c) of the Code, essentially being treated as the equivalent of a Section 2503(c) Trust. And like such a trust, the assets in a UTMA account must be distributed to the minor at age 21 years. See Rev. Rul. 59-357, 1959-2 CB
212.
What about Annual Exclusion Gifts to Adults?
As indicated, Section 2503(c) Trusts and UTMA accounts may be used
only for those under the age of 21 years. Of course, gifts may be made directly (outright) to someone 21 years of age or older, unless the donee is
incapacitated, in which case he or she is likely have a guardian who could accept the gift.
But gifts to trusts, whether for minors or adult persons, generally
are preferable. A trust provides protection from claims of creditors in many cases, may provide some protection from the foolish dissipation of wealth, may present an opportunity to reduce income
taxes and may give an opportunity to avoid estate taxation when the individual for whom the transfer was made dies. (Property in either a Section
2503(c) Trust and in a UTMA account will be included in the gross estate of the minor whether he or she dies before or after age 21 years unless expended prior to death; outright transfers, of
course, also will be included in the recipient's gross estate unless expended before death.)
One type of trust that may qualify for the annual exclusion and may
be used for an adult or a minor beyond reaching the age of 21 years is the so-called Crummey Trust, named after the famous case of Crummey v. Commissioner, 397 F. 2d 92 (9th
Cir. 1968), in which it was held that gifts to a trust for minor beneficiaries qualified to the extent they were given the immediate right to withdraw the transferred property from the trust
and even though the power to withdraw eventually would lapse. One of the additional benefits of the Crummey Trust is that, unlike a Section 2503(c)
Trust (or essentially for a UTMA account), one trust may be used for multiple beneficiaries.
Income Tax Advantages of Trusts
As indicated above, a trust may provide an opportunity for income tax
planning. Unfortunately, a UTMA account provides little planning opportunity. The income earned in an UTMA, as a general rule, is taxed directly
to the minor and may be subject to the so-called "kiddie" tax under Code Sec.1(g) (under which the income is taxed at the rates of the minor's parents, in some cases, until the child
reaches age 23 years). Thus, an UTMA provides almost no income tax advantage.
The Section 2503(c) Trust generally is treated as a taxpayer,
separate and independent of its grantor and beneficiary. Hence, income earned in the trust may be taxed to the trust instead of the minor. Although trusts reach the maximum Federal income tax bracket at quite low levels of taxable income, taxing the income to the trust may provide an opportunity to avoid state and local
income taxation. See, e.g., New York Tax Law § 605 (essentially providing that a trust without a New York trustee, New York situs property
and New York source income is not subject to New York income tax). Alternatively, distributions could be made to or for the minor causing the
trust's income (to the extent of its distributable net income, or DNI, defined in Code Sec. 643(a)) to be taxed to the minor.
Crummey Trusts with multiple beneficiaries provide even greater
flexibility in shifting taxable income: by making distributions to one (or more) beneficiaries, the trust's distributable net income (or "DNI") can
be shifted to such beneficiary (or beneficiaries), thus providing an opportunity to reduce income taxes. See Code Sec. 661 and 662.
A further potential advantage of a trust is the ability to have the
income of the trust taxed to its grantor under the grantor trust rules of the Code (Code Sec. 671 to 679). Although attributing income to the
grantor may not lower overall income taxation, it may provide significant additional tax-free transfer advantages for estate, gift and generation-skipping transfer tax planning. The grantor's payment of income tax on the income attributed to the grantor under the grantor trust rules is not a gift. Rev.
Rul.
2004-64,2004-27 I.R.B. 7. (That is one of the
reason why an assumption of a net 8% annualized return on gifts may not be unrealistically high.)
Annual Exclusion Transfers to Grandchildren
Turning now from estate tax to generation-skipping tax, there is an
annual exclusion equivalent for generation-skipping transfer tax ("GST") purposes. See Code Sec. 2642(c) of the Code. Hence, an annual exclusion gift to a "skip-person" (that is, a grandchild, more remote
descendant of the transferor or someone treated as being in the generation of such grandchild or more remote descendant) may qualify for the gift tax and GST tax annual exclusions. However, under Code Sec. 2642(c)(2), a transfer in trust will qualify for the GST annual exclusion only if the skip-person is the only beneficiary of the trust and, to the extent not
distributed to him or her during lifetime, will be included in his or her gross estate. Hence, transfers to a Section 2503(c) Trust or a UTMA
account will qualify for both exclusions. But a transfer to a multiple beneficiary Crummey Trust will not. The
cure is to use an ExtraCrummeyTrust(sm).
ExtraCrummeyTrust(sm)
The ExtraCrummeyTrust(sm) is a single document that
creates a separate trust for each one of multiple beneficiaries for purposes of using the annual exclusion. Each contribution (unless specified
otherwise at the time of its contribution) is divided into equal shares for the beneficiaries. Beneficiaries usually are defined to include all
descendants living at the time of the contribution. Hence, if the contributor has three children and six grandchildren, the contribution would be
divided into nine equal shares and with a shared added to a separate trust for each descendant then living. As the number of descendants changes
(such as by the birth of another grandchild), the division changes with respect to future contributions.
A trust may also be created under the ExtraCrummeyTrust(sm)
document for each descendant-in-law if so desired. Transfers to such a trust also should qualify for the annual exclusion. Cf. Cristofani v. Commissioner, 97 T.C. 74 (1991), acq. in result only,
Action
on Decision CC-1992-009. However, as discussed below, the property in a trust for a descendant-in-law
ultimately may be preserved for a descendant of the transferor.
Trusts for Non-Skip Persons
Each trust would provide for its beneficiary to have a Crummey power of withdrawal, allowing the transfer to qualify for the gift tax annual exclusion and, if the beneficiary is a skip-person,
for the GST annual exclusion. The power of withdrawal under each trust for a non-skip person (such as a child or child-in-law) would lapse in a
manner and time to prevent the lapse from constituting a taxable gift by the beneficiary and to prevent the trust from automatically being included in the gross estate of the non-skip persons.
Beneficiaries of the trust for a non-skip person may include the non-skip person's descendants (and spouse if appropriate), as well as, of course, the non-skip person for whom the
trust was created.
Each non-skip person, usually, is given a special testamentary power of appointment. However this may be structured so that such special
testamentary power of appointment is exercisable only with the consent of a non-adverse person, such as an independent trustee. That permits the
trustee essentially to prevent property passing in a manner the trustee determines is not consistent with the wishes of the transferor of the property. For
example, the trustee could block a child or a child-in-law from exercising the power outside of the grantor's bloodline. In default of the
effective exercise of the power of appointment, the property will remain in trust for the descendants of the non-skip person, if the non-skip person is or was a descendant of the transferor or
the descendants of the spouse of the non-skip person if the spouse of the non-skip person is a descendant of the transferor.
Although the property may not be included in the gross estate of the non-skip person who is the beneficiary of the trust, it may be subject to generation-skipping transfer tax upon the death of
the non-skip person if it passes to or for a grandchild or more remote descendant of the transferor. (There will be no such tax if it passes to or
for a child of the transferor or anyone else who is not a skip person.) Nevertheless, by exercising the special power of appointment in a certain
manner, the non-skip person can trigger the so-called "Delaware Tax Trap" causing the property subject to the power to be included in his or her gross estate pursuant to Code
Sec.2041(a)(3) and thereby be subjected to estate tax rather than GST tax. See, generally, Blattmachr & Pennell, "Using 'Delaware Tax Trap' to Avoid Generation-Skipping Taxes," 68 The Journal of Taxation 242 (April 1988).
Trusts for Skip Persons
Unlike the withdrawal power held by a non-skip person, the withdrawal
power of the skip-person will remain exercisable but, after a period sufficient to allow the transfer to the trust to qualify for the annual exclusion, it will be exercisable only with consent
of a non-adverse person, such as an independent trustee. The reason is that, as mentioned above, in order for the trust to qualify under Code
Sec. 2642(c), the trust must be included in the gross estate of the skip-person. If the power lapsed, the trust would be included in the skip-person's estate only to the extent the lapse exceed more than $5,000 or 5% of the trust. See Code Sec. 2041(b)(2). By retaining the power of appointment (even though only exercisable with the consent of a non-adverse
person), the power is treated as not lapsing and, therefore, will be included in the gross estate of the skip-person.
Each skip person, as with each non-skip person, usually will be
granted a power to appoint the trust property at death but only with the consent of a non-adverse party. It is appropriate to note that a
power of withdrawal is not a power of appointment (as the withdrawal may be exercised only in favor of the power holder) and, in any case, there likely will be more property in the trust when
the skip-person dies than the amount of which he or she was given the power of withdrawal. In any case, if a power of appointment is granted to the
skip-person, in default of its effectual exercise, the property will remain in trust for the descendants of the skip-person, if the skip person is or was a descendant of the transferor, or the
descendants of the spouse of the skip person, if the spouse of the skip person is (or was) a descendant of the transferor.
ExtraCrummeyTrust(sm) with Separate Shares Instead of Separate Trusts
One of the disadvantages of multiple trusts
may be the necessity of having to file multiple income tax returns and to maintain separate brokerage and bank accounts for each trust. During any
period that the trust is a grantor trust, no trust income tax return need be filed. See, generally, See, generally, Blattmachr & Crawford,
"Grantor Trusts and Income Tax Reporting Requirements: A Primer", Probate Practice Reporter,
Volume 13, Number 5, May 2001. However, if the trusts are not grantor trusts, a separate income tax return (Form 1041) generally will have to
be filed for each one. Grantor trust status will terminate no later than when the grantor dies (although each trust may be treated, as whole or in
part, a grantor trust under Code Sec.678 of the Code with respect to its beneficiary.)
In any case, separate trusts will necessitate,
in all likelihood, separate accounts (e.g., brokerage accounts) for each trust. Perhaps, this could be avoided by having the trusts form a common
entity (e.g., a limited partnership or limited liability company) through which they could separately invest.
An alternative under the ExtraCrummeyTrust (sm) is to
create a substantially separate and independent share for each beneficiary rather than create a separate trust for each one. A substantially
separate and independent share is treated as a separate trust for GST purposes and for certain income tax purposes. See Code Sec. 2654(b) and
663(c). Because each such share is treated as a separate trust for purposes of Code Sec. 2642(c) each transfer for a separate share for a
separate skip-person should qualify for the GST annual exclusion to the extent of the annual exclusion limit for the year. Using separate shares
may simplify income tax reporting and record keeping. If the grantor chooses to have separate shares rather than separate trusts, the trustee will be authorized in the ExtraCrummeyTrust (sm) document to "convert" any
separate share into a true separate trust.
Summary and Conclusions
The use of annual exclusions is important in estate planning. Outright transfers are simplest but provide no creditor
protection or additional tax planning and cannot effectually be used for transfers to minor. Although UTMA accounts and Section 2503(c) Trusts offer a relatively straightforward way to transfer property to minors, the requirement of payout when the minor reaches age
21 years may be problematic in some cases. Crummey trusts offer additional advantages but fail to qualify the transferred property for the GST
annual exclusion. The ExtraCrummeyTrust (sm) seems to offer some of the best advantages of all vehicles especially if it is structured
to form separate shares rather than separate trusts.
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