R. David Fritz, Jr., CLU- Managing Partner and Founder, Executive Benefits Network
Many individuals follow an annual gifting strategy that involves making gifts to trusts, including irrevocable life insurance trusts (ILITs), and rely on beneficiary withdrawal powers to avoid taxable gifts by qualifying the transfers as annual exclusion gifts.
For gifts to trusts to qualify for the annual gift tax exclusion, the beneficiaries must have a present interest in the gift. Properly structured and administered “Crummey” withdrawal powers can satisfy the present interest, but they also must comply with several requirements to reduce the risk of unintended taxable gifts (by either the grantor or the power holder) and IRS scrutiny.
For example, so called “hanging” Crummey powers can avoid inadvertent gifts by a beneficiary who failed to exercise his withdrawal rights, but may increase the amount subject to the beneficiary’s withdrawal power or result in inclusion of that amount in his or her estate. In addition, Crummey powers should only be held by individuals who have beneficial interests in the ILIT—such as current and remainder beneficiaries—and, ideally, beneficiaries should have actual notice of their Crummey withdrawal powers and a reasonable opportunity to exercise it within 30 to 60 days.
The IRS continues to review trust contributions and their qualifications as annual gift tax exclusions. Failure to comply could result in adverse gift tax consequences to the donor and/or beneficiaries. Achieving a favorable outcome on annual exclusion issues may require extensive litigation if the IRS questions the trust administration; therefore, the conservative approach for making annual exclusion gifts to a trust will follow best practice with a guard to structuring and providing notice of Crummey powers to trust beneficiaries.
Advisors may want to take this opportunity to contact donors and trustees who recently made or received annual exclusion gifts to review these Crummey power requirements, confirm past and future compliance, and to suggest corrective measures if needed.