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Grantor trusts as S stockholders.

Crummey powers are very popular in irrevocable life insurance trusts (ILITs). The Crummey power holder typically is entitled to withdraw $10,000 ($20,000 for a married trust donor) of additions to the trust each year.

The purpose is to qualify the payment of premiums by the trust donor on the life insurance policy owned by the ILIT for the annual gift tax exclusions under Sec. 2503(b). Gifts that fall within the annual exclusions do not consume a donor's unified credit equivalent, nor are they part of the adjusted taxable gifts included in the estate tax computation on the donor's death.

If the transfer into the trust does not exceed the Crummey withdrawal power, a grantor trust owned by the Crummey power holder may result. Some practitioners believe that grantor trust status for tax purposes may result in trust owner status by the beneficiary under local law. (See IRS Letter Ruling 9009010.) Such an interpretation would defeat the aims of the donor (i.e., protecting the trust assets from the beneficiary's improvidence).

However, if S stock is involved, grantor trust treatment may be preferable. A grantor trust is a permitted trust shareholder under Sec. 1361(c)(2)(A)(i), i.e., a subpart E trust first under Sec. 678 during the withdrawal period following the notice of gift and thereafter under Sec. 677. As a grantor trust rather than a QSST, no beneficiary election is required under Sec. 1361(d)(2), mandatory income distribution is not required, multiple beneficiaries are allowed and potential distributions of trust corpus to third parties are not a problem.

Grantor or subpart E trust treatment can also be obtained for a grantor retained annuity trust (GRAT) or grantor retained unitrust (GRUT) under Sec. 2702. The GRAT or GRUT must be designed so that the grantor or donor of the gift trust is considered its owner for income tax purposes.

One way to accomplish this is for the donor to retain a reversion in the GRAT or GRUT in the event the donor dies during the term of the gift trust. If this contingent reversion has an actuarial value greater than 5% of the total trust fund, the donor will be considered the trust's owner. Specifically, Regs. Sec. 1.671-3(b)(3) provides that if a grantor is treated under Sec. 673 as an owner of a trust by reason of a reversionary interest in corpus, both ordinary income and other income allocable to the corpus are "owned" by the grantor. The second method is for the donor to retain a general power of appointment in his will over the trust fund, also contingent on the donor's dying within the term of the GRAT or GRUT. (See IRS Letter Ruling 9109027.)

Note that neither a contingent reversion nor a contingent power of appointment is a "qualified interest" under Sec. 2702(b). Consequently, the value of either reserved right cannot be subtracted from the value of the trust fund in computing the taxable gift for Chapter 14 purposes. The GRAT or GRUT will, however, be a permitted trust shareholder as a subpart E trust, and the trust donor as the owner will report S income or loss.

The payment of income taxes on trust earnings by the trust donor enhances the economic value of the gift to the trust beneficiaries, since the trust is irrevocable and the trust income must be distributed currently or accumulated for future distribution to the beneficiaries on a "tax paid" basis. While it might be argued that income tax payments do not constitute a taxable gift for federal gift tax purposes, this result is uncertain. Some advisers recommend that the trust donor explicitly waive the right to recover the donor's future income tax payments from the trust fund in the trust agreement. This waiver is difficult to value for gift tax purposes and prevents an interpretation that the failure to recover income tax payments will be considered gifts each future year for which taxes are paid by the donor.
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Author:Murphy, John Joseph (American scholar)
Publication:The Tax Adviser
Date:Jan 1, 1992
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