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George F. Bearup, J.D. Senior Legal Trust Advisor

24-Jun-20

Crummey Withdrawal Powers – An Unanswered Question

Take-Away: There is no consensus on what happens when more than one donor makes a gift to a trust for a beneficiary who possesses a Crummey withdrawal right.  The lapse of the right of withdrawal is not treated as a ‘gift’ or ‘disposition of property’ if the lapse is limited to the greater of $5,000 or 5% of the trust’s corpus. Does the lapse apply to the aggregate of the Crummey transfers to the trust, or does the $5,000 or 5% lapse apply to each Crummey transfer to the trust? After 50 years one would think that the IRS would have answered this question. Apparently that is not the case.

Background: In Crummey v Commissioner, 397 F.2d 82 (9th Cir., 1968) the court held that if a trust beneficiary possesses the immediate right to demand the property contributed to a trust, the gift to the trust qualifies for the federal gift tax annual exclusion, even if that power of withdrawal lapsed soon thereafter. The IRS has accepted the Crummey ruling as an accurate statement of the law, although there continues to be a lot of controversy with regard to the need for annual written Crummey notices to the trust beneficiary. [Revenue Ruling 73-405; Treasury Regulation 25.2503-2(e), Example 1.]

5+5 Power: Generally, the release of a right to withdraw property from a trust is a gift by the beneficiary. However,  the lapse of such a right is not treated as a gift by the trust beneficiary to the extent the lapse does not exceed the greater of 5% of the value of the property held in the trust or $5,000 each calendar year. [IRC 2514(c).] This beneficiary withdrawal right is often referred to as a 5+5 power. The assets that are subject to the beneficiary’s withdrawal right will be included in the beneficiary’s taxable estate at death, which is why sometimes the withdrawal right is limited to 30 days, or limited in its exercised only during the last few weeks of a calendar year, to narrow the time when the 5+5 power can be exercised by the trust beneficiary and limit the exposure of some of the trust assets to inclusion in the beneficiary’s taxable estate.

Lapse v Release: An important semantical difference is a lapse versus a release of this power of withdrawal, which is technically a power of appointment held by the trust beneficiary. The lapse will not be treated as a gift by the beneficiary to the trust causing a gift tax, or estate tax inclusion under IRC 2036. In contrast, a release of this withdrawal right will cause the beneficiary to have intentionally transferred  estate tax consequences that arise from that release. In short, the beneficiary should always permit the withdrawal right to lapse, and not release the right by a waiver or consent to the release of that power. In short, a lapse of a 5+5 power held by a trust beneficiary is tax-free, a release carries tax consequences. [IRC 2514(c).]

Governmental Benefits: The use of a withdrawal right to fund an irrevocable trust for a special needs trust beneficiary with annual exclusion gifts can cause a big non-tax problem. If the beneficiary is receiving SSI benefits, eligibility for those SSI benefits is means-tested. If the beneficiary permits a 5+5 power to lapse, then the beneficiary is deemed to have access to that countable financial resource, and his/her lapse of their withdrawal right will be viewed as a transfer of the assets subject to the withdrawal right, thus jeopardizing the special needs beneficiary’s continuing eligibility for SSI benefits. A lapse of a withdrawal right by the SSI trust beneficiary constitutes an uncompensated transfer by the trust beneficiary. [42 USC 1396p and 42 USC 1382(c)] and thus it is treated as a countable resource of the SSI beneficiary jeopardizing the beneficiary’s eligibility for governmental benefits. [42 USC 1482b(E)(3)(B).]

Multiple Crummey Transfers-Example: Paternal grandparents decide to create a special needs trust for their disabled grandchild who receives SSI disability benefits. Since the SSI benefits are means tested the grandparents intend the special needs trust to supplement (not supplant) their grandchild’s lifestyle. Each of the paternal grandparents transfers $5,000 to the special needs trusts for their grandchild, for which there is a Crummey withdrawal right- the right to withdraw the greater of $5,000 or 5% of the trust assets, in order for the donor to claim the federal gift tax annual exclusion for their transfer to the trust. The maternal grandparents also take advantage of this same special needs trust, and they too each transfer $5,000 to the trust established for their disabled grandchild. Therefore, we have 4 donors who each contribute $5,000 to the trust in a single year for their special needs grandchild who is receiving SSI benefits, or $20,000 in total for the year. Their grandchild permits his withdrawal right to lapse as to each gift. The question is did the grandchild permit 4 separate $5,000 gifts to lapse (gift tax-free), or did the grandchild permit $20,000 to lapse (a taxable gift of $15,000). In addition, following the 5+5 rule, did the grandchild also make a transfer of $20,000 thus jeopardizing his eligibility to continue to receive SSI benefits for a period of time tied to the amount that he is deemed to have transferred ($20,000.) If the grandchild allows the right of withdrawal to lapse, that will cause a period of ineligibility for his SSI benefits, even if the lapse is not treated as a gift for gift tax purposes by reason of IRC 2514(c). [42 USC 1396p and 42 USC 1382b(c).]

The Tax Debate: ‘Heavyweight’ legal commentators disagree on how the lapse of a withdrawal right should be viewed from a tax perspective when multiple gifts to the same Crummey trust are made in the same year.

  • Some commenters say that regardless of the number of donors and trusts, only one lapse under IRC 2514(c) may occur as to each power holder, i.e. trust beneficiary, in a year. [See Gallo “Estate Planning and Generation Skipping Tax” 33 Real Property Probate and Trust Journal, page 457 (1998.)] For example, the following is a quote from Marc Chorney, “Tax Issues Raised by Crummey Powers”, 33 Real Property Probate and Trust Journal, page 775 (1998): “Revenue Ruling 85-88 does not specifically address whether more than a single five and five amount exists with respect to withdrawal powers held by a beneficiary of a single trust with multiple donors, however, the ruling’s rationale arguably can be applied in both situations, thereby limiting a beneficiary to a single five and five amount regardless of the number of trusts or transferors to the trust.”
  • Yet, in an Estate Planning Journal article this month, Jonathan Blattmachr notes: “The IRS may have indicated that the lapse can apply to each separate donation by each separate contributor. Although it might seem ‘safer’ to have each separate donation to a separate trust, it seems that the multiple ‘5 and 5’ lapses may be permitted under one trust agreement if the lapse applies separately to each separate contribution by each donor. Some commentators have reached different conclusions; it just is not certain.”
  • The Blattmachr article offers this model Crummey withdrawal trust provision: “The power of withdrawal shall lapse at the end of each calendar year separately as to the cumulative contributions made in the calendar year by one donor to the extent but only to the extent of the lapse does not, by reason of IRC 2514(c), constitute a transfer for federal gift tax purposes. To the extent the power of withdraw does not so lapse, the holder of the power of withdrawal shall continue to have the right to withdraw for health, education, maintenance and support within the meaning of IRC 2514(b)(2) but shall lapse at the end of each subsequent calendar year to the extent but only to the extent such lapse shall not, by reason of IRC 2514(c), constitute a gift for federal gift tax purposes.”
  • Over 50 years after the Crummey decision, and we still do not know for certain if the 5+5 power is for the entire year’s aggregate transfers to a trust for the beneficiary, or the power applies to each transfer to a trust where the beneficiary possesses a power of withdrawal.

Practical Solution for Uncompensated Transfer by the Disabled Beneficiary: If an irrevocable trust with Crummey withdrawal powers is contemplated for an individual who is receiving means-tested governmental benefits like SSI, there should be at least one other beneficiary of the trust, like a sibling, who does not receive, and is not anticipated to receive, governmental benefits who will be granted the Crummey withdrawal power, to allow gifts to the trust to qualify for the gift tax annual exclusion. This other individual trust beneficiary should be a legitimate trust beneficiary entitled to receive distributions, and not just a ‘strawman’ in order to avoid any IRS argument that this power holder is an illusory trust beneficiary. Thus, the assets gifted to the trust are available to be used for the disabled trust beneficiary, but he/she is not the beneficiary who possesses the right of withdrawal. This same trust might be structured as a beneficiary defective inheritor trust (BDIT) so that the other trust beneficiary is taxed on any trust income that is permitted to accumulate for the ultimate benefit of the disabled trust beneficiary (to avoid the high income tax rates imposed on trusts) with the trustee given the authority to reimburse the nondisabled trust beneficiary, or the power to eliminate the nondisabled beneficiary’s power to withdraw if the income tax consequences to the trust are not that important. [PLR 200949012.]

Conclusion: It is surprising that we still do not know if the lapse of a 5+5 power under IRC 2514(c) is applied to all donors and all trusts in a single year, or the 5+5 lapse applies to each donor, or to each trust. Most of the articles that I have read over the years with regard to the lapse of a 5+5 power suggest that the beneficiary is allowed only one lapse for all withdrawal rights and for all trusts where the beneficiary may have a withdrawal right. I was surprised to read Mr. Blattmachr suggest that the beneficiary may have multiple withdrawal rights each of which can lapse without tax consequences.