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Estate and Elder Law

Crummey Powers - A Refresher

Unless one is dealing with The Uniform Transfers to Minors Act or a minor's trust under Internal Revenue Code (IRC) §2503(c), generally, in order for one to avail themselves of the gift tax annual exclusion afforded under IRC §2503(b), the gift must qualify as a present interest. The issue is not a question of vesting, but rather, immediate possession. In order to obtain the annual exclusion, the donor must convert the future interest held in trust to a present interest. This conversion is accomplished by giving the donee/beneficiary the opportunity to withdraw the gift from the trust, known as a Crummey power, which was conceived from the facts set forth in Crummey v. Commissioner.[1] 
            A Crummey power does not create a present interest unless the beneficiary has notice that: (i) a gift has been made, and (ii) he/she has the right to withdraw. Without notice, a beneficiary’s right to withdraw is illusory. Notice must be close in time to the gift and notice requirements should be set forth in the trust to ensure notice is carried out. The trustee must give notice to each adult beneficiary and minor beneficiary’s guardian or parent (preferably not the grantor). Verbal notice has been held to be sufficient. However, the prudent approach is to provide written notice, countersigned and dated by the beneficiary to acknowledge receipt, which is held by the trustee for safekeeping. This paper trail is essential not only to combat an Internal Revenue Service (IRS) audit, but also to prevent the trustee from potentially breaching his/her fiduciary duty.
            In addition to notice, the Crummey power must provide a withdrawal period that is long enough to provide the beneficiary with adequate time to exercise the power. The IRS has routinely accepted a withdrawal period of thirty days. Anything shorter could compromise creating a present interest and make gifts ineligible for the donor’s annual exclusion. Because of this, gifts should not be made in late December for trusts where the withdrawal powers lapse at year’s end.
            Once a gift to a trust qualifies for the annual exclusion, gift tax consequences are overcome by the donor, but not with respect to a beneficiary. Rather, when a beneficiary fails to exercise the withdrawal power, which is almost always the case, the power lapses and can create unexpected gift tax consequences to a beneficiary. This tax problem is referred to as the “gift over” or “gift back.” Because the withdrawal power held by a beneficiary is a present interest, giving the beneficiary an unrestricted right to the immediate use and possession of property, such power is considered a general power of appointment. Thus, the lapse of the withdrawal power results in a transfer of the property subject to the power. Pursuant to IRC §2514(e), the value of the property subject to a lapsed power that is greater than $5,000 or 5% of the trust principal is the amount gifted by the beneficiary. This limitation to the beneficiary’s gift back is referred to as the “five-and-five” power. In avoiding this adverse gift tax consequence, trusts should be drafted to account for the five-and-five power. One such approach is to draft a hanging withdrawal power so that the excess over the five-and-five amount hangs over to future years, until the lapse of the power will not violate IRC §2514(e).
            As indicated above, there are specific formalities that must be considered when drafting Crummey powers. For those that respect these formalities, Crummey powers will often be the most effective way for donors to utilize their annual gift tax exclusion amount while fulfilling estate planning objectives. 

[1] 397 F.2d 82 (9th Cir. 1968) .