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Annual gift tax exclusion available for gifts to contingent beneficiaries.

In Cristofani, 97 TC No. 5 (1991), the Tax Court upheld the annual gift tax exclusions claimed by the settlor of an irrevocable inter vivos trust for gifts made to contingent trust beneficiaries. The beneficiaries, who did not possess a substantial current or future economic interest in the trust corpus, had the right under the trust document to withdraw from the settlor's contributions to the trust an amount not exceeding the $10,000 annual limitation.

Under the terms of the trust created by the taxpayer, her two children were to receive all the income from the trust on a quarterly or more frequent basis. After the taxpayer's death, the trust was to be divided into as many equal shares as there were children of the taxpayer then living or children of the taxpayer then deceased but leaving issue; the taxpayer's children had to survive her by 120 days to receive the corpus distribution. The trust agreement also provided that, during a 15-day period following a contribution, each of the taxpayer's children and the right to withdraw an amount not to exceed the annual gift tax exclusion under Sec. 2503(b)--$10,000. The trustee could also apply principal for the support, health, maintenance and education of the children, taking into account several factors including the "Settlor's desire to consider the Settlor's children as primary beneficiaries and the other beneficiaries of secondary importance."

The trust agreement also provided that during the 15-day period following a contribution to the trust, each of the five grandchildren had the same right of withdrawal as their parents (i.e., the taxpayer's children). The grandchildren's only other interest in the trust would arise if one of the taxpayer's children failed to survive her by 120 days.

The taxpayer funded the trust in 1984 and 1985. In each year, she transferred an undivided one-third interest in improved real property to the trust. The value of each contribution was $70,000. The taxpayer did not report the transfers on federal gift tax returns for 1984 and 1985, but instead claimed seven annual exclusions of $10,000 each (for the two children and five grandchildren). On audit, the IRS allowed annual exclusions for the two children, but disallowed the exclusions claimed for the grandchildren. In the Service's opinion, the grandchildren had not received gifts of a present interest, as required under Sec. 2503(b).

The Tax Court held that the taxpayer was entitled to claim an annual exclusion for each grandchild; each grandchild had an unrestricted right to withdraw within 15 days of a contribution to the trust by the taxpayer an amount not exceeding the $10,000 annual exclusion, which constituted a present interest for purposes of Sec. 2503(b). The IRS attempted to distinguish this case from Crummey, 397 F2d 82 (9th Cir. 1968), by arguing that the trust beneficiaries in Crummey not only possessed an immediate right of withdrawal, but also possessed "substantial, future economic benefits" in trust corpus and income. In contrast, the primary beneficiaries of the trust in Cristofani were the taxpayer's children; the taxpayer's grandchildren held only contingent remainder interests in the trust, which vested only in the event that their parents predeceased the taxpayer or failed to survive her by more than 120 days.

The court rejected the notion that Crummey requires that the beneficiaries of a trust have a vested present interest or vested remainder interest in the trust corpus or income to qualify under Sec. 2503(b). The court also clarified that the likelihood that a beneficiary will actually receive present enjoyment of the property is not the test for determining whether a present interest was received; rather, the focus is on the true legal rights of the parties--that is, whether the beneficiaries may legally exercise their right to withdraw trust corpus, and whether the trustee may legally resist the beneficiary's demand. Noting that there was no agreement or understanding among the taxpayer, the trustees and the beneficiaries that the grandchildren would not exercise their withdrawal rights, the court held that each grandchild possessed the legal right to withdraw trust corpus (even though it was never exercised), and that the trustees had no legal right to prevent that withdrawal.

The court also rejected the Service's argument that since the grandchildren possessed only contingent remainder interests in the trust, the taxpayer never intended to benefit her grandchildren, and that the only reason the grandchildren had the right to withdraw trust corpus was to obtain the benefit of the annual exclusion. The court observed that, although the taxpayer's children were in good health when she established the trust, the children nevertheless could have predeceased her. Moreover, the grandchildren's failure to exercise their withdrawal rights did not vitiate the fact that they had the legal right to do so.

It should be noted that, although letter rulings do not have precedential value, the court found persuasive IRS Letter Ruling 9030005 (4/19/90), which involved facts very similar to Cristofani. In that ruling, the Service relied on Crummey to find that the settlor was entitled to annual gift exclusions for all persons with withdrawal rights, including contingent beneficiaries.
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Author:Thompson, James G.
Publication:The Tax Adviser
Date:Dec 1, 1991
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