That’s Crummey! A Closer Look at Crummey Trusts and How they Work

Section 2501(a)(1) of the Internal Revenue Code imposes a tax on “the transfer of property by gifts.” Section 2501 specifies the method of computation to be used in the determination of the gift tax liability to “taxable gifts” after recognition of the allowance of certain exclusions and deductions. Under Section 2503(b), a taxpayer may exclude from “the total amount of gifts” for a calendar year (the starting point in the computation of taxable gifts) of up to $19,000 (the 2026 annual exclusion amount) to each donee. However, with respect to any donee this exclusion of $19,000 is reduced, until consumed, by the amount of previous gifts to the same donee in the same calendar year.

The use of the annual gift tax exclusion of $19,000 (2026 exclusion amount) is, and should be, an integral part of a wealth transfer plan. The first $19,000 of gifts of present interests in property made to any person by a single donor during a calendar year is exempt from gift tax. With proper planning and documentation, married donors may give up to $38,000 annually to an individual donee through gift-splitting. To qualify for the annual exclusion, the gift must be an unrestricted right to the immediate use, possession, or enjoyment of the property or the income from the property. If a beneficiary or several beneficiaries of a trust receive future interests in a trust, which would not ordinarily qualify for annual exclusions under Section 2503(b) of the Internal Revenue Code, the interests may be accorded the status of excludable present interests if the beneficiaries are given what are commonly referred to as “Crummey powers.” Named after a Ninth Circuit Court of Appeals case, Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), Crummey powers are powers given to beneficiaries to make effective outright demand for property held in trust, thus a present right to possession is equal to possession.

Crummey powers have traditionally been given to income beneficiaries of a trust where a transfer to the trust does not qualify (either in whole or in part) for an annual exclusion. The Internal Revenue Service (“IRS”) has held that in order to constitute a valid Crummey power, the holder of the power must have a “substantial economic interest” in the trust. See, TAM 8727003 (Mar. 16, 1987). However, the essence of a Crummey power is that the recipient of the power has the right to extract the property subject to the power from the trust corpus. Thus, Crummey holds that transfers by a grantor to a trust qualify for the annual gift tax exclusion, if the beneficiaries have a limited right to obtain all or part of the gift upon demand. Under Crummey, the limited demand right “transforms” the gift in trust to the beneficiaries from a future interest to a present interest, thus qualifying for the annual gift tax exclusion.

As a result of the Crummey decision, so-called Crummey Trusts have become a wealth transfer tool. Since Crummey was decided, the IRS has various procedural guidance regarding Crummey trusts and the qualification for the annual gift tax exclusion under the principles of Crummey. Currently, the IRS has required that:

1. A beneficiary must have actual notice of the withdrawal right;

2. A beneficiary must have actual notice of any contribution to the trust to which the withdrawal right attaches;

3. Notice must be given to the natural parents or guardian of a beneficiary who is a minor, if one is appointed on the minor’s behalf;

4. A beneficiary cannot waive the “requirement” for notice of annual contributions;

5. The contribution must consist of, or the trust must contain, liquid assets sufficient to satisfy the beneficiary’s withdrawal demand; and

6. The contribution(s) must be made before expiration of the notice period.

Despite the ongoing IRS rulings and interpretations of Crummey powers, the Tax Court in Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), expanded the applicability of Crummey provisions by permitting annual gift tax exclusions for contributions to a trust on behalf of contingent trust beneficiaries holding Crummey powers. The holding in Cristofani contradicted Tech. Adv. Mem. 90-45-002 (July 27, 1990).

Potential Drawbacks

A Crummey trust is an effective wealth transfer tool because it permits the settlor to make tax-free annual exclusion gifts to an irrevocable trust while maintaining control over when the beneficiaries receive the funds. A Crummey Trust also may provide creditor protection for the assets placed in the trust from the personal liabilities of the trust settlor or the beneficiaries of the trust. However, there are strict rules governing the establishment of a Crummey Trust and there are a number of administrative complexities that must be carefully followed to administer such a trust. For example, formal “Crummey notices” must be sent to the beneficiaries of the trust every time a contribution is made to the trust. The Crummey notices must give the beneficiaries a temporary (30 to 60 day) window to withdraw funds from the trust. If a beneficiary were to exercise his or her withdrawal right, the intended accumulation of trust may dramatically change. A potential settlor of a Crummey Trust must consider these potential drawbacks.

Suggested Trust Provisions

In order to avoid potential estate, gift, and generation-skipping transfer taxes, a Crummey Trust may be carefully drafted. As indicated above, a Crummey trust relies on providing trust beneficiaries a temporary right to withdraw contributions . In essence, the trust converts a future interest gift into a present interest gift in order to qualify for the annual gift tax exclusion. In order avoid an IRS challenge or an inadvertent tax consequence, at a minimum a Crummey Trust should contain the following provisions:

The Trust Should Identify the Trust’s Beneficiaries

The trust should state each person that will receive Crummey withdrawal rights. This typically includes the children, grandchildren, or other family members of the trust creator. Each beneficiary added creates a potential annual gift tax exclusion. In other words, if the creator of a Crummey trust has two children as beneficiaries, the trust settlor can contribute up to $38,000 (two beneficiaries x $19,000 per beneficiary in 2026) without the trust creator consuming his or her lifetime exemption or triggering a gift tax.

The Trust Should Take Into Consideration Contingent Beneficiaries

In the event a primary beneficiary of a Crummey trust dies before receiving his or her full distribution, the trust must take into consideration such a possibility. The trust can contain three drafting options.

1. First, the trust can provide for a distribution per stirpes to descendants. This means the deceased beneficiary’s children inherit their parent’s share. If a primary beneficiary of the trust predeases the trust settlor, his or her children inherit the portion of the trust the primary beneficiary would have received.

2. The trust can provide for the passing to other primary beneficiary keeps assets within the trust settlor’s original beneficiary group. If one child dies, the other children share that child’s portion equally.

3. The trust can name contingent beneficiaries that would receive the primary beneficiaries gift.

The Trust Should Have Crummey Withdrawal Rights

The trust settlor must establish a pro rata withdrawal amount for the trust beneficiaries. The pro rata share ensures each beneficiary gets an equal opportunity to withdraw their portion of your contribution. The trust should specifically refer to the “5 and 5” power. The “5 and 5” power is a rule that limits how much a beneficiary can withdraw from a trust without triggering an unintended gift or estate tax, A beneficiary has the annual right to withdraw the greater of $5,000 or 5% of the total value of the trust assets. This power resets every calendar year. When a Crummey withdrawal right expires or lapses, Section 2514(e) of the Internal Revenue Code treats it as a legal “release” of a general power of appointment. If there is a lapsed withdrawal right under the 5 and 5 power lapses, there are no tax consequences.

Below, please find examples as to how the “5 and 5” power operates.

Let’s assume a trust settlor contributes $30,000 to a trust with three children as beneficiaries. The pro rata calculation gives each child a $10,000 withdrawal right. If your trust holds $200,000 in assets, the 5 and 5 power would allow up to $10,000 per beneficiary (5% of $200,000). The annual exclusion limit is $18,000. The “lesser of” language means each child gets a $10,000 withdrawal right – the smallest of these three calculations.

The “5 and 5” Problem and Hanging Powers

When a beneficiary’s withdrawal right lapses, the Internal Revenue Code treats that lapse as a gift from the beneficiary to the other beneficiaries but only to the extent it exceeds the greater of $5,000 or 5% of the trust assets.

For example, a trust settlor contributes $30,000 to a trust holding $80,000 in existing assets. Each of three children gets a $10,000 withdrawal right. When the rights lapse, each child makes a deemed gift of $6,000 (the $10,000 withdrawal right minus the greater of $5,000 or $4,000 (5% of $84,000 total trust assets after the contribution).

The “hanging power”  or the withdrawal rights lapse only to the extent it won’t create a deemed gift, with the excess continuing as a cumulative right that lapses in future years.

Notice Requirement Considerations

At a minimum the trust must provide for the sending of notices to trust beneficiaries for withdrawal periods from the trust. A 30-day withdrawal period is standard. Shorter withdrawal periods such as 15 days have been successfully challenged by the IRS in court as not giving the beneficiaries a “meaningful” opportunity to withdraw from a Crummey trust.

The Trust Should Consider Distribution methods

The trust settlor must consider how the trust will ultimately make distributions to the beneficiaries of the trust at the time of his or her death. There are fundamentally three different distribution methods discussed below.

Outright distribution. The trust may make an outside distribution to the beneficiaries of the trust when the trust settlor dies. This option assumes that beneficiaries of the trust will be mature enough at the age to manage the gift.

Staggered distributions. The trust can provide for staggered distributions. For example, the trust may distribute one-third of the gift at the time the beneficiary reaches 18 years of age, one-third at the time the beneficiary reaches 25 years of age, and one-third when the beneficiary reaches 30 years of age. Staggering the distributions protects a beneficiary from making poor financial decisions.

Lifetime Discretionary Trust. A discretionary trust is a legal arrangement where a trustee has full powers to decide how and when money or property is distributed to a beneficiary. A trust settlor may elect to use such an arrangement to provide asset protection to the beneficiary of the trust and professional trust management.

Conclusion

In the proper circumstances, a Crummey Trust can be a valuable wealth planning tool.
Any considering establishing a Crummey Trust should consult with a qualified tax attorney.

Anthony Diosdi is a domestic and international tax attorney at Diosdi & Liu, LLP. Anthony is a frequent author and speaker on a number of tax topics.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.