Crummey GST tax trap.

Under Sec. 2503(b), annual gifts of present interests up to $10,000 (indexed for inflation) per donee are exempt from the gift tax (the annual exclusion). Generally, a transfer in trust is not considered a transfer of a present interest to a trust's beneficiary. However, in Crummey, 397 F2d 82 (9th Cir. 1968), a transfer in trust was considered a transfer of a present interest, because the trust instrument permitted the beneficiary to withdraw the transferred amount for a limited period of time (often 30 days or less). Thus, so-called "Crummey powers" are often used to allow a transfer of a $10,000 gift to a trust to qualify for the annual exclusion.

In Crummey, the withdrawal power's holder was the trust's ultimate beneficiary. In more recent cases, such as Estate of Cristofani, 97 TC 74 (1991), and Estate of Kohlsaat, TC Memo 1997-212, the trust agreements were drafted to give withdrawal rights to individuals who did not have substantial economic interests in the trust. Typically, by pre-arrangement or understanding, none of these withdrawal rights will be exercised. (See Tax Clinic, "Annual Exclusions Allowed for Contingent Trust Beneficiaries," TTA, September 1997, p. 544.)

GST Tax Annual Exclusion

An annual exclusion is also available for the generation-skipping transfer (GST) tax. However, under Sec. 2642(c), the GST tax annual exclusion does not apply to any transfer to a trust for an individual's benefit unless:

* During that individual's life, no portion of the trust's corpus or income may be distributed to (or for the benefit of) any other person; and

* If the trust terminates before the individual dies, the trust's assets will be includible in his gross estate.

Pres. Clinton's FY 2001 Budget Proposal

Reasons for change. The granting of a withdrawal right to a person who does not have a primary interest in a trust to obtain the use of an additional exclusion is an unreasonable expansion of the annual exclusion and the Crummey decision. Thus, the Cristofani and Kohlsaat decisions should be overruled. In addition, the mechanics of issuing withdrawal notices under Crummey are burdensome. Finally, the differing requirements for an annual exclusion under the gift tax and the GST tax provide a trap for the unwary. This area would be simplified if the gift tax rules and the GST rules were conformed.

Proposal. The gift tax annual exclusion rule should be conformed to the GST tax rule. The gift tax annual exclusion would not apply to any transfer to a trust for an individual's benefit unless:

* During that individual's life, no portion of the trust's corpus or income may be distributed to (or for the benefit of) any other person; and

* If the trust terminates before the individual dies, the trust's assets will be includible in his gross estate.

No withdrawal right or notice to the beneficiary would be necessary for a transfer to such a trust to qualify for the annual exclusion. The proposal would be effective for transfers to trusts after 2000; a grandfather rule would apply to trusts in existence on the date of enactment. The grandfather rule would maintain existing law (allowing the use of Crummey powers to create a present interest), but would disallow any annual exclusion attributable to a withdrawal right if a person is not-a primary, noncontingent beneficiary of the trust.

The Secretary may prescribe regulations necessary to carry out the purposes of this proposal, including rules for determining whether an annual exclusion is attributable to a withdrawal right.

FROM STUART R. JOSEPHS, CPA, TAX ASSISTANCE PRACTICE (TAP), SAN DIEGO, CA