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Inadvertant use of beneficiaries' unified credit on gifts in trusts.

When creating a trust for the benefit of others, most grantors are interested in maximizing that transfer, free of gift tax consequences to themselves. Maximizing use of the grantor's unified credit often has the unintended result of creating gift tax consequences to the trust beneficiaries.

Sec. 2511 (a) provides that the Federal gift tax imposed by Sec. 2501 applies to a transfer by gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect and whether the property is real or personal, tangible or intangible. Sec. 2503(b) provides an annual exclusion of $10,000 for gifts of present interests. Gifts of future interests are not eligible for the exclusion. Regs. Sec. 25.2503-3(b) states that a present interest is the right to immediate use, possession or enjoyment of property or its income. A present interest is given if the beneficiaries have the power to demand immediate possession and enjoyment of corpus or income (Crummey, 397 F2d 82 (9th Cir. 1968)).

Ordinarily, most transfers to trusts are gifts of future interests and therefore do not qualify for the $10,000 annual exclusion. The goal of the grantor of the trust is to use as much of the annual exclusion as possible against the transfer. This goal is often accomplished by providing the beneficiaries with an annual Crummey withdrawal power. Typically, under this sort of arrangement, the trust beneficiary is given the power to demand from the trustee an amount of corpus equal to the lesser of the annual gift tax exclusion or the amount of the gift to the trust.

Example 1: G creates an irrevocable trust for the benefit of his two children. The terms of the trust permit each beneficiary to withdraw on a noncumulative basis $10,000 annually or their proportionate share of the fair market value of the property contributed to the trust, whichever is less. In 1993, G transfers $18,000 to the trust.

No gift tax consequences arise to G. The $18,000 transfer to the trust, by using the Crummey withdrawal provision, gives each child an immediate right to withdraw $9,000, thereby making the transfer one of a present interest and falling within the $10,000 exclusion per donee.

One often overlooked aspect to this transaction is the gift tax consequences to the beneficiary. Sec. 2514(b) states that the exercise or release of a general power of appointment will be deemed a transfer of property by the individual possessing such power. Sec. 2514(e) provides that the lapse of a power is to be treated as a release of the power, but only to the extent that the property that could have been appointed by the exercise of such lapsed power exceeds the greater of $5,000 or 5% of the aggregate value of the assets out of which the lapsed power could have been exercised. Therefore, when a beneficiary chooses not to exercise his Crummey withdrawal power, the lapse of that power is treated as a gift back to the trust for the amount in excess of the greater of $5,000 or 5% of the trust corpus.

Example 2: Assume the same facts as in Example 1. In addition, the trust corpus is valued at $150,000. On lapse of the Crummey powers by the beneficiaries, the beneficiaries will be treated as having made a gift of $1,500 back to the trust. Furthermore, this gift back to the trust is one of a future interest and consequently does not qualify for the $10,000 annual exclusion.

The $1,500 gift arises because when the beneficiaries let their Crummey powers lapse, the lapse is treated as release of a power of appointment under Sec. 2514(e), and therefore taxable under Sec. 2514(b).

But it is only taxable to the extent the amount that could have been appointed ($9,000) exceeds the greater of $5,000 or 5% of the trust corpus (5% x $150,000 = $7,500), resulting in a $1,500 taxable gift back to the trust.

A carefully drafted trust instrument will usually limit the Crummey withdrawal power to the least of (1) $10,000, (2) the amount of the annual gift or (3) the greater of $5,000 or 5% of the trust corpus. This provision will eliminate the gift tax exposure to the beneficiary; however, for smaller trusts it will limit the amount that can be transferred tax free to the trust to an amount less than the annual exclusion.
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Article Details
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Author:Monks, Laurance
Publication:The Tax Adviser
Date:Oct 1, 1993
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