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Why relying on Cristofani to draft trust withdrawal powers is a "Crummey" idea.

The Internal Revenue Service recently issued two separate administrative pronouncements that substantially curtail aggressive use of so-called "Crummey powers." These two pronouncements[1] restate and clarify the IRS's position regarding its past acquiescence in Estate of Cristofani v. Commissioner,[2] which has been construed by some to allow annual gift tax exclusions based on a contingent or "naked" Crummey power.

Understanding Crummey, Powers

Use of the annual gift tax exclusion of $10,000 per donee is, and should be, an integral part of most wealth transfer planning. The first $10,000 of gifts of present interests in property made to any person by a single donor during the calendar year is exempt from gift tax.[3] With proper planning and documentation, married donors may give up to $20,000 annually to an individual donee through gift-splitting.[4] To qualify for the annual exclusion, the gift must be an unrestricted right to the immediate use, possession, or enjoyment of the property or the income from the property.[5] As we shall see, it is the present interest restriction on gift tax exemptions that gives Crummey powers their significance.

In the landmark decision of Crummey v. Commissioner,[6] the court upheld for the first time the application of the annual gift tax exclusion to gifts by a settlor to a grantor trust that had as its beneficiaries minor children with a limited right to withdraw the gift from the trust. Crummey holds that transfers by a grantor to a trust qualify for the annual gift tax exclusion, if the beneficiaries have a limited right to obtain all or part of the gift upon demand. Under Crummey, the limited demand right "transforms" the gift in trust to the beneficiaries from a future interest to a present interest, thus qualifying it for the annual gift tax exclusion.

Since Crummey, it has become de rigueur to insert in trust agreements a right for the contingent beneficiaries to obtain the present benefit of all or part of annual gifts during a limited window of time[7] in order to qualify those gifts for the $10,000 per donee annual gift tax exclusion. A typical "Crummey power" provides as follows:

Each beneficiary shall be notified at least annually by the trustee in writing, by registered mail, sent to a last known address or guardian's address, of any gifts to the trust and the amount thereof subject to the withdrawal rights hereinafter. granted. Upon receipt of this notification, a beneficiary shall have the right to demand distribution within 30 days of an amount equivalent to the beneficiary's pro rata share of total cash or property gifts made by the grantor to the trust during the reported period, but in no case shall the beneficiary have the right to demand distributions in one calendar year for an amount in excess of the annual gift tax exclusion contained in IRC [sections] 2503(b) or successor law. The withdrawal right shall not be cumulative and will lapse as to the annual reported amount if not validly exercised within the 30-day period

More complete Crummey powers might address notice and demand provisions for the guardian of a minor, the required form for exercise of beneficiary's demand right, or limitations on the amount subject to demand after consideration of the so-called "5 and 5" power.[8]

Crummey Refined

During the 43 years since Crummey was decided, the IRS, through various procedural mechanisms, has tightened the requirements for qualifying for the annual gift tax exclusion under the principles of Crummey. For example, the IRS has required that:

1) A beneficiary must have actual notice of the withdrawal right;[9]

2) A beneficiary must have actual notice of any contributions to the trust to which the withdrawal right attaches;[10]

3) Notice must be given to the natural parents or guardian of a beneficiary who is a minor, if one is appointed on the minor's behalf;[11]

4) A beneficiary cannot waive the "requirement" for notice of annual contributions;[12]

5) The contribution must consist of, or the trust must contain, liquid assets sufficient to satisfy the beneficiary's withdrawal demand;[13] and

6) The contribution(s) must be made before expiration of the notice period.[14]

Despite continuous IRS rulings and interpretations restricting Crummey powers, the Tax Court in Estate of Cristofani v. Commissioner,[15] surprisingly expanded the applicability of Crummey provisions by allowing annual gift tax exclusions for contributions to a trust on behalf of contingent trust beneficiaries holding Crummey powers.[16] In Cristofani, the settlor established a trust under which her two adult children were the vested beneficiaries and her five minor grandchildren were contingent beneficiaries of the remainder, their interests vesting only if the grandchild's parent predeceased the settlor or failed to survive the settlor by more than 120 days.[17]

The IRS challenged two annual transfers of $70,000 intended to take advantage of seven separate annual gift tax exclusions, but only as to the five annual exclusions claimed with respect to the minor grandchildren."[18] The Tax Court relied on Crummey to uphold the gift tax exclusions because the grandchildren had the unrestricted legal right to exercise the withdrawal power, and because a prearranged agreement to refrain from exercising the powers did not exist. With the emphasis on the "legal right" to exercise the power, Cristofani has been read not only to allow the annual gift tax exclusion for contingent interests that are subject to a Crummey power, but also for "naked" Crummey powers, that is, withdrawal rights by parties lacking any beneficial interest in the trust other than the Crummey power itself.[19]

The IRS Speaks

The IRS issued AOD 1992-09[20] shortly after the Cristofani decision, indicating that it acquiesced in the Cristofani result only. But AOD 199209 contains a strong warning:

[T]he IRS will deny exclusions for powers held by individuals who either have no property interests in the trust except for Crummey powers, or hold only contingent remainder interests. To extend the gift tax benefit of Crummey powers to beneficiaries with interests more remote than current income or vested remainders would undermine significantly the unified system of estate and gift taxation which Congress intended, and would invite flagrant abuse in the future.... Me disagree with the Tax Court's sweeping interpretation of Crummey. Accordingly, we shall litigate other cases whose facts indicate a greater abuse of the Crummey power than those of Cristofani.

Despite the fact that AOD 1992-09 indisputably attacks the propriety of giving Crummey powers to contingent beneficiaries and holders of "naked" powers, practitioners are still using contingent and "naked" Crummey powers in their estate planning, as evidenced by the factual scenario presented in TAM 9628004.

The IRS Speaks Again

In TAM 9628004,[21] the IRS was presented with a complex scheme of three separate trusts created by the same settlor. Thirteen separate family members (three children of the settlor, the three spouses of these children, and seven grandchildren of the settlor) held Crummey powers over the first trust (Trust A), which provided for outright distribution on the settlor's death of 50 percent of the corpus to one of the settlor's children, or to his issue if the child failed to survive the settlor, and 50 percent of the corpus to a second trust (Trust B). Accordingly, Trust A conferred a vested remainder in the trust on one of the settlor's children and the remaining Crummey powerholders either had contingent interests or no interest at all. Further, none of the six Crummey powerholders (four spouses of the settlor's grandchildren and two great-grandchildren) in a third trust (Trust C) had any income or remainder interest in the trust, other than the current withdrawal right (i.e., a true "naked" Crummey power). The IRS disallowed the 13 annual gift tax exclusions claimed for Trust A and the six annual gift tax exclusions claimed for Trust C.

The IRS denied the annual gift tax exclusions claimed for Trust A for want of bona fide intent to gift present interests. The Crummey powerholders were notified of the trust gifts on December 27, 1990, with their right to withdraw the gifts expiring on December 31, 1990.[22] Actual funding of the gifts was made on January 2, 1991.[23] The .Crummey powers in Trust A were predictably deemed illusory because the gift subject to the powers was not completed until after the expiration of the withdrawal period.[24] The IRS's analysis of the Crummey powers in Trust C is much more revealing.

The IRS used a two-part inquiry to disallow the six annual gift tax exclusions for Trust C. First, the IRS used an economic analysis, recognizing that current income beneficiaries and persons with vested remainder interests have an economic incentive to consider whether to receive the immediate benefit of a current withdrawal pursuant to the Crummey power or to receive a future (and presumably larger) benefit by allowing the Crummey power to lapse. The IRS reasoned that contingent beneficiaries and holders of "naked" Crummey powers lack a similar economic dilemma. Indeed, the IRS found "no ... logical reason why these individuals would choose not to withdraw $10,000 a year as a gift which would not be includible in their income or subject the Donor to gift tax."[25] And in what should be of critical concern to estate planners, the IRS went one step further and presumed that nonexercise of Crummey powers by holders of contingent remainders and "naked" interests is an indication that some prearranged understanding exists that the rights are "paper rights only" that will not be exercised.[26]

As an alternative explanation, the IRS rejected the annual gift tax exclusions claimed for Trust C under a substance-over-form analysis.[27] This analysis tests whether creating individual trusts for each Crummey powerholder would achieve the desired gift planning result. If so, the gift tax exclusion is upheld. This test emanates from the U.S. Supreme Court's opinion in Helvering v. Hutchings,[28] which held that a taxpayer may claim an annual gift tax exclusion for each beneficiary of a single trust, because the taxpayer could achieve a similar result by creating multiple trusts, one for the benefit of each single beneficiary. In TAM 9628004, the IRS concluded that Trust C could not have been created as six separate trusts and still accomplish the settlor's intent of benefiting her children. The IRS determined that, in creating Trust C, the settlor did not intend to benefit the holders of the "naked" Crummey powers, because, once the withdrawal period elapsed, the holders of those powers did not have any rights in the trust. The Crummey powers were considered a tax-avoidance scheme because the form of the demand power did not comport with the substance of the gift.

AOD 1996-0 10,[29] issued several months after TAM 9628004, supplements AOD 1992-09 and uses the analysis of TAM 9628004 to reinforce the attack on Cristofani. Under a similar economic analysis, the IRS approves of granting Crummey powers to current income beneficiaries and persons with vested remainder interests because these persons must weigh the withdrawal right against their long-term economic interest in the trust. However, the economic analysis renders suspect "naked" Crummey powers and powers granted to contingent beneficiaries because those parties lack a significant continuing economic interest in the gifts once the withdrawal right lapses.

AOD 1996-010 further attacks Cristofani using a substance-over-form analysis to pierce the Tax Court's "legal right" reasoning. This analysis calls into question restrictions that hinder the exercise of a Crummey power in any meaningful way. Examples given by the IRS include a prearranged understanding that the power will go unexercised, or a situation in which exercise of the Crummey power would trigger adverse consequences to its holder, such as when the trust document provides that beneficial rights under the trust will be altered if the holder of a Crummey power exercises the withdrawal right. A legal right to exercise a Crummey power is not enough, argues the IRS, if other facts indicate the power is likely to go unexercised.

The Final Warning

TAM 9628004 and AOD 1996-010 raise serious questions as to the extent of the IRS's "acquiescence" in Cristofani. These pronouncements reveal that the IRS's current position is that granting a Crummey power to one who has no other beneficial interest, or only a contingent interest in a trust, unquestionably fails to qualify the donor for an annual gift tax exclusion under IRC [sections] 2503(b). As a result, continued reliance on Cristofani to support aggressive wealth transfer using Crummey powers is simply a crummy idea.

[1] Tech.Adv. Mem. 96-28-004 (Apr. 1, 1996). A.O.D. 1996-010 (July 15, 1996).

[2] 97 T.C. 74 (1991).

[3] See I.R.C. [sections] 2503(b).

[4] See I.R.C. [sections] 2513.

[5] See Treas. Reg. [sections] 25.2503-3(b).

[6] 397 F.2d 82 (9th Cir. 1954).

[7] The open period for demand under a Crummey power is subject to some uncertainty. Various IRS rulings have approved open periods of 30 days, Priv. Mr. Rul. 8134-135, six weeks, Priv. Mr. Rul. 80-47-131, 60 days, Priv. Ltr. Rul. 80-14-078, and 90 days, Priv. Ltr. Rul. 80-15-133; however, the Tax Court in Cristofani approves of, and the IRS failed to contest, a much shorter 15-day open period. Cristofani, 97 T.C. at 75.

[8] Because Crummey powers are considered general powers of appointment, the failure to exercise a Crummey power is a lapse of a general power of appointment. To the extent the lapse exceeds the greater of $5,000 or five percent of the aggregate value of the property from which the exercise of the power could have been satisfied, the lapse of the power of appointment may constitute a taxable gift. See I.R.C. [sections] 2514(e). Full discussion of the "5 and 5" exception is beyond the scope of this article.

[9] Tech. Adv. Mem. 79-46-007 (July 26, 1979).

[10] Rev. Rul. 81-7, 1981 C.B. 474.

[11] Priv. Ltr. Rul. 82-29-097 (Apr. 22, 1982). There is no requirement, however, that a minor must have an appointed guardian in order to validate the Crummey power. See Rev. Rul. 73-405, 1973-2 C.B. 321.

[12] Tech. Adv. Mem. 95-32-001 (Apr. 12, 1995).

[13] Tech. Adv. Mem. 84-45-004 (June 27, 1984); Priv. Ltr. Rul. 81-18-051 (Feb. 9, 1981).

[14] Rev. Rul. 81-7, 1981 C.B. 474; Tech. Adv. Mem. 96-28-004 (Apr. 1, 1996).

[15] 97 T.C. 74 (1991).

[16] The holding in Cristofani directly contradicted existing IRS authority. See, e.g., Tech. Adv. Mem. 90-45-002 (July 27, 1990).

[17] Cristofani, 97 T.C. at 75-76.

[18] Id. at 77-78.

[19] See, e.g., Note, Crummey Trusts: An Exploitation of the Annual Exclusion, 21 Pepp. L. Rev. 83, 105-06 (1994) ("Following Cristofani, the number of exclusions one can obtain is merely restricted by the number of people who will most probably not exercise their demand rights").

[20] A.O.D. 1992-09 (Apr. 6, 1992).

[21] Tech.Adv. Mem. 96-28-004 (Apr. 1, 1996).

[22] Id. at 21-22.

[23] Id. at 5.

[24] Bernice J. Koplin, IRS Targets "Abusive" Crummey Powers, ABA Section of Taxation Newsletter, fall 1996, at 5.

[25] Tech. Adv. Mem. 96-28-004 at 33.

[26] Id. at 26, 33.

[27] See Gregory v. Helvering, 293 U.S. 465 (1935).

[28] 312 U.S. 393 (1941).

[29] A.O.D. 1996-010 (July 15, 1996).

Gregory M. McCoskey is an associate with Glenn Rasmussen & Fogarty, P.A., Tampa. He is a graduate of the University of Maryland, cum laude, and the University of Georgia School of Law, with honors. A member of the Georgia and Florida bars, as well as a certified public accountant licensed in Georgia, Mr. McCoskey practices in the areas of bankruptcy / creditors' rights, probate administration, and probate litigation.

This column is submitted on behalf of the Tax Section, Lauren Young Detzel, chair, and Michael D. Miller and David C. Lanigan, editors.
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Author:McCoskey, Gregory M.
Publication:Florida Bar Journal
Date:Jul 1, 1997
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