What is the advantage of a Crummey trust?

The Tax Cuts and Jobs Act (TCJA) has reduced estate tax concerns for many families, but estate tax liability remains a concern for some. Notably, you may implement strategies in the wake of the TCJA that are designed to reduce future exposure to federal and state estate taxes.

One such option, a Crummey trust, remains a viable option. Despite its odd-sounding name, derived from the landmark case authorizing its use, the results are anything but crummy.

“Present interest” vs. “future interest”

Under the annual gift tax exclusion, you can give gifts to each recipient, valued up to a specific limit, without incurring any gift tax. The limit for 2019 is $15,000 per recipient, the same as it was in 2018. (This amount is indexed for inflation, but only in $1,000 increments.) Therefore, if you have, for example, three adult children and seven grandchildren, you can give each one $15,000 this year, for a total of $150,000, and pay zero gift tax. The exclusion is doubled to $30,000 a year for gifts made jointly by a married couple.

If you give outright gifts, however, you run the risk that the money or property could be squandered, especially if the recipient is young or irresponsible. Alternatively, you can transfer assets to a trust and name the child as a beneficiary. With this setup, the designated trustee manages the assets until the child reaches a specified age.

But there’s a catch. To qualify for the annual exclusion, a gift must be a transfer of a “present interest.” This is defined as an unrestricted right to the immediate use, possession or enjoyment of the property or the income from it. When a gift is placed in a trust and it accumulates income without being distributed to the beneficiary, it doesn’t qualify as a gift of a present interest. Instead, it is treated as a gift of a “future interest” that is subject to gift tax.

Crummey trust in action

This is where a Crummey trust can come to the rescue. It satisfies the rules for gifts of a present interest without requiring the trustee to distribute the assets to the beneficiary.

Typically, periodic contributions of assets to the trust are coordinated with an immediate power giving the beneficiary the right to withdraw the contribution for a limited time. However, the expectation of the donor is that the power won’t be exercised. (The trust document cannot expressly provide this.)

As a result, the beneficiary’s limited withdrawal right allows the gift to the trust to be treated as a gift of a present interest. Thus, it qualifies for the annual gift tax exclusion. Note that it’s the existence of the legal power — not the exercise of it — that determines the tax outcome.

Potential obstacles

To pass muster with the IRS, the beneficiary must be given actual notice of the withdrawal right, along with a reasonable period to exercise it. Generally, at least 30 days is required.

It’s recommended that you spell out the notification in writing. Also, you should obtain a written acknowledgment from the beneficiary or the beneficiary’s representative. Furthermore, the trust may limit the withdrawal right to the lesser of the amount of the annual gift tax exclusion or the fair market value of the property contributed to the trust.

Finally, the IRS may challenge arrangements that provide limited withdrawal rights without any other economic interest in the income or principal of the trust. These are sometimes referred to as “naked” Crummey powers. Accordingly, the IRS has ruled that the beneficiaries of a Crummey trust must have an actual economic interest in the trust property to meet the present interest requirement. (For example, the beneficiaries should have a vested right to principal or income.)

Is a Crummey trust right for you?

There are several variations on this theme, but the crux is that a Crummey trust provides a limited withdrawal right for beneficiaries while periodic contributions qualify for the annual gift exclusion. This technique may meet your estate planning objectives. Please contact our Family Wealth and Individual Tax Group concerning use of a Crummey trust for your situation.

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Estate planning is important for many reasons, no matter how large or modest your estate is. It can prevent unintended beneficiaries, protect your children, and eliminate family chaos. For wealthier individuals, it can also ensure that you transfer your wealth from one generation to the next while paying as little in taxes as possible.

A Crummey trust is an excellent tool used in estate planning, and it’s anything but crummy. Named after a famous tax case involving Reverend Crummey and the IRS in the 1960s, this type of irrevocable trust is a creative way to provide financially for both your children and grandchildren while paying no gift taxes and reducing your taxable estate.

To make a Crummey trust work for you, it must be administered properly. Here’s a breakdown of how exactly it works.

What You Need to Know About Crummey Trusts

A Crummey trust is a vehicle to transfer assets from one generation to the next tax-free. This type of trust will also limit your children and grandchildren’s decision-making power over the transferred assets. If you’re hesitant to give outright gifts to your loved ones for fear they will squander the gifts, then a Crummey trust might be the right tool for you.

The provisions of a Crummey trust are specifically designed to allow the money placed in the trust to qualify for the annual gift tax exclusion. The gift’s value cannot exceed the permitted annual exclusion amount, which is $15,000 for tax year 2019.

Be careful not to overlook the proper administrative details, as the IRS carefully scrutinizes Crummey trusts. It is only considered a tax-free gift if the beneficiary has the right to take the money placed in the trust in the short term.

Therefore, you must give the recipient the right to make one withdrawal from the trust each year during a specified window, such as 30 days. You also must inform them of their right to withdraw funds from the trust by sending out a “Crummey letter” every year. The idea is to make the right available in such a way that it is not exercised.

The Tax Advantage of a Crummey Trust

Because a Crummey trust is an irrevocable trust, once you have moved your funds into the trust, those funds are no longer considered part of your estate. This means that someday when you die, the money you placed in the trust will not be taxed with the rest of your wealth.

Good Things Come from Crummey Trusts

Crummey Trusts are scrutinized carefully by the IRS, and they have been the targets of much litigation. It is essential to comprehend the workings of a Crummey Trust fully and to craft the trust language clearly. We recommend working with a professional each year, as it’s always a smart idea to have another set of eyes on your Crummey letters.

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When it comes to handling your financial assets and transferring them to beneficiaries, often your children, a spouse, or long-term domestic partner, you have some choices to make for managing the distribution of these funds. Various types of trusts help you plan for the future of your loved ones, even after you’re gone. If you choose to place financial gifts in a trust, you’ll want to know how to minimize or eliminate taxes on them so your family benefits more from your estate than the IRS. This is where a Crummey trust can come in handy.

What Is a Crummey Trust?

A Crummey trust is specifically designed to transfer assets, usually to minor or adult children, though anyone can be a beneficiary. The purpose of a Crummey trust is to avoid gift taxes on the bequeathed assets.

How Does a Crummey Trust Work?

A Crummey trust works differently than other types of trusts in terms of taxation. This type of trust also differs in the transfer of assets and withdrawals of funds for beneficiaries. At the onset of creating a Crummey trust, a set window of time is established, specifying how long the beneficiary has to withdraw any assets. In some cases, a beneficiary may withdraw assets within the first month after the trust is created and funded.

What is the advantage of a Crummey trust?

Image via Flickr by free pictures of money

This short window of withdrawal power allows them to present interest in the monetary gifts included in the trust. This is the most valuable feature of a Crummey trust, as it’s the aspect that allows you to reduce gift taxes or eliminate them when transferring financial assets to a minor child, adult child, or any other beneficiary you choose to include in the Crummey trust.

Technically, a beneficiary could withdraw funds from the trust during the initial window of time set, but that would be unlikely in the case of a minor child. If no assets are withdrawn during the period you set for the window, any monetary gifts you’ve put into the trust will remain there until a later date. According to the terms and timeline you set within the trust, the beneficiary will withdraw them in the future. It’s the responsibility of the trustee to adhere to the terms of the trust you established at its creation.

What Are the Advantages of a Crummey Trust to Estate Planning?

The primary advantage of including a Crummey trust in your estate planning is the benefit of how tax laws handle financial gifts in a Crummey trust. If your beneficiary refrains from withdrawing any funds from the trust during the initial withdrawal period set, funds added to the trust for them will then be exempt from taxes due to an annual gift tax exclusion.

The gift tax exclusion is limited to $15,000 per tax-paying individual. If you’re a couple who files a joint tax return, you’d be permitted to gift a combined $30,000 per child, on an annual basis, without it being included in a gift tax. However, you could still be required to file a gift tax return when preparing your taxes.

To make the gift tax exclusion rule work, you’ll need to make sure that your Crummey trust has a legitimate withdrawal period, during which your beneficiary will be allowed to withdraw funds from the trust. Withdrawals probably won’t be an issue with minor children, as you will likely set up the trust on their behalf.

In the case of adult children or other adult beneficiaries, you can specify that no other financial gifts will be added to the trust if any assets are taken out of the trust during the set withdrawal period. This can serve as an incentive to prevent beneficiaries from seeking to withdraw trust assets too soon.

While Crummey trusts are often used primarily for the transfer of wealth, they can also be helpful in college fund planning. For example, you could earmark funds in the trust to be used for college tuition only. Or you could set other conditions, such as your child having to turn a certain age or complete college before being permitted access to the trust. The advantages to Crummey trusts are that they provide you with precise control of trust assets and a timeline for distribution to your beneficiaries while also providing tax benefits.

What Are Crummey Powers?

Under the tax laws governing Crummey trusts, the gift tax exclusion applies to gifts given up to $15,000 per year per person. There’s one loophole, though, that may allow gifts in excess of $15,000 a year without triggering any gift tax under an addition to the annual gift tax exclusion. There’s a federal estate tax lifetime exclusion as well, which allows up to $11.7 million per person. Therefore, if you decide to put annual gifts in excess of $15,000, you’re permitted to deduct them from your lifetime exclusion.

Should You Create a Crummey Trust?

Crummey Trusts aren’t suitable for everyone. For example, most people cannot annually gift beneficiaries large sums of money via a trust. However, a Crummey trust might be a good choice for you if you’ve been fortunate enough to have amassed substantial wealth over the years and are looking for a financial vehicle to hold annual gifts to your beneficiaries in a trust.

Another reason you may want to create a Crummey trust reduces the size of your estate so that you can minimize the amount of estate taxes your estate would be forced to pay at the time of your passing. This means your beneficiaries, often your closest family members, will be able to keep more of the money you worked so hard for to help them have a bright future.

If you’re near the Lake Forest, Illinois area, and need more information about Crummey trusts, planning a college fund, other forms of financial planning, and wealth management, please feel free to reach out to the accounting and consulting professionals at Pasquesi Sheppard. We’re experienced in all matters involving taxes, auditing, bookkeeping, and an array of other financial services. You can call (847) 234-5000 or fill out a contact form on our website Financial Planning & Consulting in Lake Forest to set up a consultation to discuss your financial goals and help you plan for the future.