906 / When will the gift tax annual exclusion be available with respect to gifts of property in trust?

A gift of property to a trust which directs the trustee to distribute the trust income annually to the beneficiary is a present interest gift of an income interest qualifying for the annual exclusion. However, a gift of property to a trust which directs the trustee to distribute from the trust annually a certain dollar amount to the beneficiary is a gift of a future interest not qualifying for the exclusion.

A gift of property in trust will qualify for the gift tax annual exclusion if the trust terms (1) provide that the trust beneficiary (or beneficiaries) be given timely written notice (notice given within 10 days after the transfer has been held timely) that the beneficiary has a reasonable period (45 days has been held reasonable) within which to demand immediate withdrawal (usually the trust specifies that the withdrawal right is limited to the amount of the exclusion), and (2) give the trustee the power to convert property in the trust to cash to the extent necessary to meet withdrawal demands. Such trusts are popularly known as Crummey trusts, after the name of a leading case that upheld them.¹

The IRS has ruled with respect to Crummey trusts that the annual exclusion could not be applied to trust contributions on behalf of trust beneficiaries who had withdrawal rights as to the contributions (except to the extent they exercised their withdrawal rights) but who had either no other interest in the trust (a naked power) or only remote contingent interests in the remainder.² However, the Tax Court has rejected the IRS’ argument that a power holder must hold rights other than the withdrawal right to obtain the annual exclusion. The withdrawal right (assuming there is no agreement to not exercise the right) is sufficient to obtain the annual exclusion.³ (Language in Cristofani appears to support use of naked powers, although the case did not involve naked powers.) The Tax Court recently held the donor does not have to give the beneficiaries of a trust notice of the gift in certain circumstances.⁴

In an Action on Decision, the Service stated that, applying the substance over form doctrine, the annual exclusions should not be allowed where the withdrawal rights are not in substance what they purport to be in form. If the facts and circumstances show an understanding that the power is not meant to be exercised or that exercise would result in undesirable consequences, then creation of the withdrawal right is not a bona fide gift of a present interest and an annual exclusion should not be allowed.⁵ In TAM 9628004, annual exclusions were not allowed where transfers to trust were made so late in the first year that Crummey withdrawal powerholders had no opportunity to exercise their rights, most powerholders had either no other interest in the trust or discretionary income or remote contingent remainder interests, and withdrawal powers were never exercised in any year. However, annual exclusions were allowed where the IRS was unable to prove that there was an understanding between the donor and the beneficiaries that the withdrawal rights should not be exercised.⁶ In TAM 9731004, annual exclusions were denied where eight trusts were created for eight primary beneficiaries, but Crummey withdrawal powers were given to 16 or 17 persons who never exercised their powers and most powerholders held either a remote contingent interest or no interest other than the withdrawal power in the trusts in which the powerholder was not the primary beneficiary.

The annual exclusion was not allowed where the beneficiaries waived their right to receive notice of contributions to a trust with respect to which their withdrawal rights could be exercised. Furthermore, the annual exclusion was not allowed because the grantor set up a trust which provided that notice was to be given to the trustee as to whether a beneficiary could exercise a withdrawal power with respect to a transfer to a trust and the grantor never notified the trustee that the withdrawal powers could be exercised with respect to any of the transfers to trust.⁷