By: Kevin M. Helmich, Esq.
Through a consistent program of annual exclusion gifting, an individual can dramatically reduce the size of his or her taxable estate. For those persons fortunate enough to have an estate with a value in excess of the unified credit equivalent ($5.49 million in 2017), an annual schedule of gifting can result in significant estate tax savings.
The Annual Exclusion:
Each year, a person can gift up to $14,000 to as many separate individuals as he or she desires. A married couple can combine their annual gifting capacity for a total of $28,000 per recipient. The number of recipients is unlimited, and there are no restrictions as to the identity of recipients. This exemption is called the annual gift tax exclusion.
Gifts are not taxable as income to the recipient, nor does the person making the gift receive an income tax deduction for making the gift. The primary tax benefit of gifting is to reduce the value of the taxable estate for estate tax purposes. The appreciation of gifted assets is also removed from the taxable estate.
Irrevocable Trusts containing “Crummey” Provisions:
To qualify for the annual gift tax exclusion, a gift must be of a “present interest”. In other words, the person receiving the gift must have the present right to possess and use the gifted asset without restriction. This can cause problems if the intended recipient of a gift is a minor, or if he or she is not experienced or responsible enough to manage the gift. Many people would prefer to gift assets to a trust for the benefit of the recipient of the gift. The trust can be managed by a trustee for the benefit of the recipient. This keeps the recipient from being frivolous with gifted assets. Unfortunately, gifts in trust generally do not qualify as gifts of a “present interest”.
Let’s say that a donor established a trust for the benefit of an 18 year old child. The trust was to be managed by an independent trustee. The trustee could distribute the trust assets for the child’s health or education. When the child hit 35 years of age, the trust would dissolve and the trustee would distribute the assets of the trust to the child outright. Gifts to this trust would not qualify for the annual gift tax exclusion. There is, however, a solution. What if the trust said that the child could withdraw money gifted to the trust for 30 days from the date of the gift? If the child did not withdraw the funds in 30 days, then the trust assets would be held for the child’s benefit and distributed when the child reached 35 years of age. Such a temporary right of withdrawal is called a “Crummey Power” (named after a famous tax case), and a trust containing this type of provision is called a “Crummey Trust”. Because the child would have the right to withdraw the gift at the time it was made, a gift to a Crummey Trust qualifies for the annual gift tax exclusion. The fact that a child may fail to exercise the right of withdrawal would have no impact.
Leveraged Gifting to “Crummey Trusts”:
Crummey withdrawal rights may be given to all beneficiaries of an irrevocable trust, including contingent beneficiaries. This can greatly leverage the ability to make gifts. An example will illustrate:
Donor establishes a trust for the benefit of her three children. If a child dies, the children of the deceased child receive the deceased child’s interest. Assume that two of Donor’s children each have three children. The other child is not yet married. Donor can contribute $14,000 to the trust for each of her children (a total of $42,000), and give each child a Crummey right of withdrawal. Donor can further contribute $14,000 to the trust for each of her grandchildren (a total of $84,000), and give each grandchild a Crummey right of withdrawal. All nine gifts qualify for the annual gifting exclusion.
This type of leveraged Crummey trust can result in more than increased gifting capacity; it can held to ensure equitable treatment among family members. If the Donor had made the above gifts to her children and grandchildren outright, two branches of her family would have each received $56,000, while her unmarried child would have received only $14,000. The trust could be drafted so that as of Donor’s death, the trust proceeds would be divided equally among her three children. If all Donor’s children were alive at the time of the Donor’s death, the grandchildren would receive nothing. This allows our Donor to leverage gifting by including the grandchildren, but treat all of her children equally.
Annual exclusion gifting can play an important role in reducing potential estate tax liability. The benefit of a continued schedule of gifting compounds over time, making implementation of gifting advisable at an early age. A properly designed gifting program, which may include the use of an irrevocable trust, can greatly increase the wealth passing from one generation to the next.