162 / If the beneficiary of a Crummey trust allows the right to withdraw a contribution to the trust to go unexercised, when will the beneficiary be deemed to have made a transfer subject to gift or estate tax?

The withdrawal power held by a Crummey trust beneficiary is a general power of appointment. If a Crummey trust provides for a contingent beneficiary to succeed to the interest of the primary beneficiary in the event of the primary beneficiary’s death before the trust terminates, the primary beneficiary’s failure to exercise the withdrawal right acts as a transfer to the contingent beneficiary, either at the time of the lapse of the withdrawal right or at the time of the primary beneficiary’s death. The amount thus transferred is subject to federal gift or estate tax to the extent it exceeds the greater of $5,000 or 5 percent of the aggregate value of the assets out of which, or the proceeds of which, the exercise of the withdrawal right could be satisfied.¹

A spouse who is given a withdrawal power would be treated as making gifts to remainder persons each time the spouse allows a withdrawal power to lapse to the extent that the lapsed power exceeds the greater of $5,000 or 5 percent of the trust principal. Furthermore, the value of the gift would not be reduced by the spouse’s retained income interest or the spouse’s interest in principal subject to an ascertainable standard because such interests are not qualified retained interests under IRC Section 2702.²

In 2024, in those cases where (1) the primary beneficiary’s gift or estate tax liability is to be avoided, and (2) the trust value is less than $360,000 in the case of an $18,000 withdrawal right, or less than $720,000 in the case of a $36,000 withdrawal right (two spouses, as grantors, splitting the gift), the “5 or 5” limitation must be considered.

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Planning Point: A hanging power is one method that has been used in an attempt to manage the “5 or 5” limitation. A hanging power is designed to lapse in any year only to the extent that the power does not exceed the $5,000 or 5 percent (“5 or 5” limitation). Any excess is carried over to succeeding years and lapses only to the extent that the power does not exceed the “5 or 5” limitation in such years.

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Example. Beginning in 2002, parents transfer an amount equal to eight (2 donors x 4 donees) times the annual exclusion to a trust each year. Four children are each given a right to withdraw an amount equal to two (2 donors) times the annual exclusion annually. Upon non-exercise of the power to withdraw, the power lapses in any year to the extent of the greater of $5,000 or 5 percent of corpus. To the extent that a power does not lapse in a year, it is carried over and added to any power arising in the succeeding year. The hanging power is eliminated in the tenth year (i.e., when carryover equals zero).

YEAR	CORPUS ($)	POWER ($)	LAPSE ($)	CARRYOVER ($)
2002	80,000	20,000	5,000	15,000
2003	168,000	37,000	8,400	28,600
2004	256,000	50,600	12,800	37,800
2005	344,000	59,800	17,200	42,600
2006	432,000	64,600	21,600	43,000
2007	528,000	67,000	26,400	40,600
2008	624,000	64,600	31,200	33,400
2009	720,000	57,400	36,000	21,400
2010	824,000	47,400	41,200	6,200
2011	928,000	32,200	32,200	0

In Letter Ruling 8901004, a hanging Crummey withdrawal power written in the form of a tax savings clause was ruled invalid. Many commentators believe that a hanging power that lapses only to the extent that the power does not exceed the “5 or 5” limitation (rather than by reference to whether there would be a taxable gift) would be valid.

A power holder is not treated as making a gift upon the lapse of a general power if the power holder is, in effect, still the owner of the property after the lapse. Consequently, other methods used in an attempt to manage the “5 or 5” limitation include giving the power holder a testamentary limited power to appoint the property to other than the power holder or the power holder’s estate, and vesting the property in the power holder.

Under each of these methods for managing the “5 or 5” limitation for gift tax purposes, estate tax inclusion could result ( Q 181, Q 205).

Since August 24, 1981, the IRS has had the following types of Crummey insurance trust under extensive study and has stated that it will not issue rulings or determination letters on the applicability of IRC Section 2514(e) to a beneficiary’s lapse of a withdrawal power when:

(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 677.³