Crummey Powers Targeted by 2015 Budget Proposal

President Obama's proposed budget for fiscal year 2015 includes several important tax changes, some  of which would, if adopted, impact many estate, financial, and business succession plans.  Most of the proposals that appear in each year’s budget proposal never make it into law, or even into the following year’s budget proposal.  It is worth noting the proposals, however, because they represent what the President would sign into law if unbridled by the legislative process,  and what might end up as potential bargaining chips in the legislative process.  

The latest budget proposal includes the elimination of Crummey powers in estate planning   under the misleading title, “Simplify Gift Tax Exclusion for Annual Gifts.” Crummey powers are currently drafted in a trust in order to allow a gift to the trust to qualify for the annual gift tax exclusion. By granting the beneficiary of the trust the right for a limited period of time to withdraw the gift, the Crummey powers give the beneficiary a “present interest” in the gifted property, allowing the gift to qualify for the annual exclusion.  Without the Crummey powers, the gifts would be considered incomplete or future gifts, meaning that the gifts would be taxable. Crummey powers are named for the Ninth Circuit decision in Crummey v. Comm’r, 397 F.2d 82 (9th Cir. 1968), which approved and explained the use of this tool to satisfy the present interest requirement for gifts.

Currently individuals can gift up to $14,000 a year per donee without reporting the gift for gift  tax purposes.  Under current law, everyone can each transfer up to $5.34 million tax-free during life or at death without incurring a tax of up to 40% on the gifts. That figure is called the basic exclusion amount and is adjusted for inflation. In addition, widows and widowers may be able to add any unused exclusion of the spouse who died most recently to their own, thus permitting them together to transfer up to $10.68 million tax-free.

The annual gift tax exclusion, however, does not apply to gifts to a trust unless the donor gives the beneficiaries Crummey powers.  Crummey powers are central to many estate planning trusts.  Crummey powers are used by wealthy donors, for example, to create trusts for multiple beneficiaries and gift large amounts of money to the trust tax-free.  By drafting a trust with a large number of beneficiaries, some of which will never exercise their withdrawal power or ultimately receive a distribution from the trust, each additional donee means  more property can be transferred using the annual exclusion.

But, the technique is also used by not-so-wealthy individuals to protect life insurance benefits from taxation.  The planning technique is particularly effective and commonly used in irrevocable life insurance trusts that utilize annual exclusion gifts to fund large insurance premiums on the life of the grantor.  These trusts, while also common in wealthy estates, are also popular in more modest estates where the risk of estate taxes is particularly unacceptable, such as for family farmers, or family business owners.  These insurance trusts often provide taxpayers the best opportunity to leverage their annual exclusion, and can be a key part of ensuring necessary liquidity for an estate.

The new proposal would eliminate the present interest requirement and Crummey powers altogether. Instead, there would be a new category of transfers that would allow a donor to give an additional annual maximum of $50,000 within this category and qualify for the gift tax exclusion. The new category would include transfers in trust and transfers to other entities that normally do not qualify as a transfer of a present interest. This means, however, that if the donor gave more than $50,000, the gift would be taxable, even if the total gifts to individual donees did not exceed $14,000.  It also means that existing wealth transfer trusts, such as irrevocable life insurance trusts, that currently require or intend a total annual contribution or gift in excess of $50,000, would begin to eat into the current  lifetime exclusion. 

The proposal explains the administration’s justification for the change:

"The IRS’s concern has been that Crummey powers could be given to multiple discretionary beneficiaries, most of whom would never receive a distribution from the trust, and thereby inappropriately exclude from gift tax a large total amount of contributions to the trust. (For example, a power could be given to each beneficiary of a discretionary trust for the grantor’s descendants and friendly accommodation parties in the hope that the accommodation parties will not exercise their Crummey powers.)  The IRS has sought (unsuccessfully) to limit the number of available Crummey powers by requiring each powerholder to have some meaningful vested economic interest in the trust over which the power extends. See Estate of Cristofani v. Comm’r, 97 T.C. 74 (1991); Kohlsaat v. Comm’r, 73 TCM 2732 (1997).”

The IRS has attempted for some time to challenge the broad use of Crummey powers by arguing that each beneficiary must have a reasonable chance or expectation of receiving the property held in the Crummey trust.  The Tax Court has repeatedly rejected this argument, holding that the legal right to withdraw funds creates the present interest, thus upholding the right of taxpayers to employ such trusts. 

The Proposal also notes  the administrative costs to the taxpayers who utilize this planning technique and the costs to the IRS in enforcing the rule. Of course, by administrative costs to the taxpayer the  proposal means the legal and accounting fees taxpayers willingly pay in order to avoid what they consider to be an onerous additional tax on wealth transfer, wealth acquired only after paying taxes for an entire lifetime on income and realized gain, and the taxpayer expense in fighting the IRS as it has attempted to challenge otherwise court-approved Crummey powers.  By IRS costs in enforcing the rule, the proposal ostensibly includes the cost of the IRS’s protracted battle against taxpayers to limit Crummey powers, which would undoubtedly be saved.  

To read the Proposal, click here.