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.

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.

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).