A Crummey trust, also known as an irrevocable gift trust (“IGT”), is a type of irrevocable trust. A Crummey trust is designed to help reduce estate tax liability by utilizing an individual’s annual gift tax exemption. However, a Crummey trust, like most irrevocable trusts, requires a settlor to sacrifice control in exchange for the benefit of the trust.
As emphasized in this post on the estate and gift taxes, the estate tax does not impact most people. In most situations, a couple needs to have roughly $10,000,000 in assets for the estate tax to be an estate planning issue. However, with a top tax rate of 40%, couples facing estate tax liability should consider a Crummey trust as a tool to help reduce estate tax liability.
There are annual and lifetime exemptions for the gift tax. For 2014, 2015, and 2016, the annual gift tax exemption is $14,000 per recipient. In other words, an individual may give as many $14,000 gifts to as many individuals as he or she wishes and not incur gift tax liability. Notably, a married couple may double the gift tax exemption to $28,000 per recipient.
As with the revocable living trust, an irrevocable trust is created by a settlor, who may also be a beneficiary of the trust. However, the critical difference with an irrevocable trust is that the settlor may not also be the trustee. In other words, the settlor must give up control of assets held and managed by the trust. It is also more difficult to amend or revoke an irrevocable trust in general, and the settlor is prohibited from amending or revoking the trust.
Why do people create Crummey trusts? The primary reason is estate tax avoidance. The settlor designates a number of beneficiaries for the trust, typically children and other relatives. Each year, the settlor transfers the full amount of the annual gift tax exemption for each beneficiary to the trust. At death, the assets held by the trust not only avoid probate, they are also excluded from the decedent’s estate and thereby reduce the decedent’s estate tax liability. Importantly, the settlor is not only excluding the amount of the annual gift tax exemption, he or she is also excluding all capital gains that accrue on the gift between gifting and death (however, it is important to note that, from an income tax perspective, an irrevocable trust is a separate taxpayer that is taxed at a higher rate more quickly than an individual or married taxpayer). The assets of the trust are distributed to the beneficiaries according to the terms of the trust.
How does a Crummey trust achieve estate tax avoidance? The key is the “crummey” power. In order to be considered part of an individual’s annual gift tax exemption, instead of the lifetime gift tax exemption, the gift must qualify as a present interest. Therefore, a Crummey trust is structured so that the beneficiaries technically have the power to demand a distribution of the assets gifted to the trust within a reasonable period of time (generally 30 days) after the beneficiaries receive notice from the trustee that a gift was made to the trust. The power is called a “crummey” power, and the notice is called a “crummey” letter. The power to withdraw lapses after the period specified in the “crummey” letter (generally 30 days).
Although a settlor cannot prohibit a beneficiary from demanding a distribution, there is usually an understanding that, if the beneficiary makes a withdrawal, the settlor will not make gifts to the trust on behalf of the beneficiary in future years.
As a practical matter, how does this work? John Doe, the settlor, creates a Crummey trust called the John Doe Irrevocable Gift Trust. John names his sister, Jane, as trustee, and names both of his two children as beneficiaries. In December 2015, John transfers $28,000 into the trust. After the gift has been received, Jane notifies John’s children that they have 30 days to demand a withdrawal from the trust. 30 days passes with no withdrawal, and the power lapses. John has reduced his estate tax liability by $28,000, plus the income that the principal will generate between the time of transfer and John’s death.
If you have additional questions about Crummey trusts or are ready to have one prepared, call or come visit with the estate planning attorneys at the Paul Law Firm. Consultations are always free!