161 / Do transfers to a trustee of an irrevocable life insurance trust of amounts to be used by the trustee to pay premiums qualify for the gift tax annual exclusion?

Although such transfers would ordinarily be future interest gifts, it has been held that they will be treated as present interest gifts, qualifying for the exclusion, to the extent the trust beneficiaries are given immediate withdrawal rights with respect to the amounts transferred.¹ Such trusts are known as Crummey trusts, after the case of Crummey v. Commissioner.²

Example. G creates an irrevocable insurance trust for each of his four children, transferring amounts (additions) from year to year to fund the trusts. Two of the children are minors when the trusts are created and for several years thereafter, but neither has a court-appointed guardian. The trusts provide that with respect to the additions, each child may demand in writing at any time (up to the end of the calendar year in which an addition is made) the sum of $5,000 or the amount of the addition, whichever is less, payable immediately in cash. If a child is a minor when an addition is made, the child’s guardian may make such demand on the child’s behalf and hold the amount received for the benefit and use of the child. To the extent demands for payment are not made by the beneficiaries, the trustee is directed to use the additions to pay insurance premiums as needed and to purchase additional insurance and investments for the trust. G transfers to each trust $5,000 each year the trusts are in existence. Each trust provides that it is irrevocable for the lifetime of the beneficiary and that the trust assets will revert to the grantor only if the beneficiary dies before age 21. All children survive past age 21. By the rule of the Crummey case, G is entitled under present law to $20,000 in gift tax annual exclusions each year ($5,000 for each child). It does not matter that the minor children never had guardians appointed. Had the trusts given the beneficiaries immediate payment rights of no more than $2,000 each with respect to the additions, G’s exclusions would be limited to $8,000 per year (assuming he made no other present-interest gifts to his children during the year).

The IRS has ruled that when the beneficiary of a discretionary trust was a competent adult, contributions to the trust did not qualify for the annual exclusion because the beneficiary did not receive timely notice or have actual knowledge of the right to demand immediate distribution of contributions.³

Another ruling allowed the annual exclusion where the trust provided for timely written notice to the beneficiaries of their withdrawal rights, and where the beneficiaries were given a 30-day period within which to exercise their withdrawal rights.⁴

Yet another ruling allowed the exclusion where the trust required the trustee to notify the beneficiaries within seven days of receipt of additional contributions and further required that the beneficiaries be given 30 days after receipt of notice within which to exercise their withdrawal rights.⁵ If the beneficiary is given reasonable notice of the right to withdraw and a reasonable time within which to exercise the right, the fact that a calendar year ends between the date of the transfer and the date the beneficiary received notice does not transform a present interest gift into a future interest gift.⁶

The annual exclusion was not allowed, however, when the beneficiaries waived their right to receive notice of contributions to the 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 that 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 the trust and the grantor never notified the trustee that the withdrawal powers could be exercised with respect to any of the transfers to the trust. Thus, the gifts were not transfers of a present interest under the meaning of IRC Section 2503(b).⁷

The value of a withdrawal right may be reduced, even to zero, if the trustee has discretion to invade the trust corpus for the benefit of non-Crummey beneficiaries.⁸ The exclusion is allowed only to the extent there is cash, or assets reducible to cash, in the trust to satisfy any beneficiary demand rights, or to the extent the trustee is required to maintain sufficient liquidity to meet immediate withdrawal demands.⁹

Where appointment of a legal guardian would be necessary to enable a beneficiary to exercise the withdrawal right, sufficient time (at least 30 days) should be allowed to make the appointment before the right to withdraw terminates.¹⁰ “If there is no impediment under the trust or local law to the appointment of a guardian and the minor donee has a right to demand distribution, the transfer is a gift of a present interest that qualifies for the annual exclusion allowable under Section 2503(b) of the Code.”¹¹

Reciprocal Crummey trusts have been unsuccessfully tried in an attempt to increase each donor’s annual exclusion. In Revenue Ruling 85-24,¹² A, B, and C, partners in the X partnership, each created a Crummey trust for their children. Each contributed $20,000 to the trust initially. A’s trust gave his child, F, a power to withdraw $10,000 of the contribution within 60 days, and gave B and C each the power to withdraw $5,000 on the same terms. B’s trust gave his child, G, the power to withdraw $10,000, and gave A and C each the power to withdraw $5,000. C’s trust gave his child, H, the power to withdraw $10,000, and gave A and B each the power to withdraw $5,000. A, B, and C each claimed a $20,000 gift tax exclusion for the year in which the trusts were created. The IRS ruled that A, B, and C were entitled to only a $10,000 exclusion for the gifts to their children. No gift tax exclusions were allowable with respect to the Crummey powers the partners gave one another. These transfers, according to the IRS, were not gifts because they were based on adequate consideration, namely, the consideration for the reciprocal transfers among the partners was each partner’s forgoing the exercise of the right of withdrawal in consideration of the other partners’ similar forbearance. The IRS said further that upon the lapse of a partner’s withdrawal power, the child’s gift (from his parent) was increased by $5,000, but the failure of the partner to exercise the power was not considered a lapse of a general power of appointment (i.e., not a gift) because the transfer to the partner was not a gift.

Since August 24, 1981, the IRS has had the following types of Crummey insurance trusts under extensive study and has stated that it will not issue rulings or determination letters on the allowability of the gift tax annual exclusion for transfers of property to such trusts until it resolves the issues through publication of a revenue ruling, revenue procedure, or regulation:

(1)     The trust corpus consists or will consist substantially of insurance policies on the life of the grantor or the grantor’s spouse;

(2)     The trustee or any other person has a power to apply the trust’s income or corpus to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse;

(3)     The trustee or any other person has a power to use the trust’s assets to make loans to the grantor’s estate or to purchase assets from the grantor’s estate;

(4)     The trust beneficiaries have the power to withdraw, on demand, any additional transfers made to the trust; and

(5)     There is a right or power in any person that would cause the grantor to be treated as the owner of all or a portion of the trust under IRC Sections 673 to 677.¹³

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.¹⁴ The Tax Court, however, has rejected the IRS’s 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.¹⁵ (Language in Cristofani appears to support use of naked powers although the case did not involve naked powers.) The IRS has 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.¹⁶

In TAM 9628004, annual exclusions were not allowed where transfers to the trust were made so late in the first year that Crummey withdrawal power holders had no opportunity to exercise their rights, most power holders 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.¹⁷ In TAM 97310004, annual exclusions were denied where eight trusts were created for eight primary beneficiaries, but Crummey withdrawal powers were given to
16 persons who never exercised their powers; most power holders held either a remote contingent interest or no interest other than the withdrawal power in the trusts in which the power holder was not the primary beneficiary.

Substance over form analysis may be applied to deny annual exclusions when indirect transfers are used in an attempt to obtain inappropriate annual exclusions for gifts to intermediate recipients.¹⁸ For example, suppose that in 2025, A transfers to B, C, and D $19,000 each. By arrangement, B, C, and D each immediately transfer $19,000 to E. The annual exclusion for A’s indirect transfers to E is limited to $19,000 and A has made taxable gifts of $38,000 to E. Under the appropriate circumstances, the substance over form analysis might even be used to deny annual exclusions for Crummey powers.