Are you thinking about setting up a trust for a child, grandchild, or other loved one? You should be aware that transfers into a trust may be subject to gift tax. With careful planning and a Crummey provision, you may be able to reduce or eliminate this tax burden.
The Estate / Gift Tax Exclusion
Before getting into how the Crummey provision works, here are a few key points to refresh us on how the estate / gift tax works.
- When a donor transfers property or money to a non-spouse in the form of a gift or a bequest, the donor is responsible for any tax associated with the transfer.
- For 2018, each individual can transfer $11.2 Million ($22.4 million per couple) in property over their lifetime before any transfers are taxable.
- A donor is able to exclude annual transfers to each donee of up to $15,000 before transfers start to count against the exemption amount.
In order for the exclusion to apply, the transfer must be a gift of a present interest.
A present interest gift is one that is made to a donee which they receive unrestricted and have immediate access to use and enjoy.
A gift of a future interest is not eligible for the exclusion.
A future interest is an interest for which the benefits are enjoyed in the future.
A Gift of Present Interest
A common scenario exists when a donor funds a trust that names the donor as the trustee. The transfer is generally considered a gift of a future interest to a beneficiary and does not qualify for the annual exclusion. This is because the trust property is controlled by the trustee, and therefore, the beneficiary does not have uninhibited enjoyment of the benefits of ownership in the property.
Setting up a Crummey trust allows the donor to fund a trust for the donee’s benefit using the exclusion amounts. The benefit is the donor gets to fund the trust without generating gift tax or eating into their overall lifetime exemption amount.
The Mechanics of a Crummey Trust
Here is how it works. First, the donor contributes assets to the trust. Then a beneficiary is given a written notice that gives them the opportunity to withdraw the property from the trust for a period of time (usually 30 days). The right of withdrawal must give the beneficiary unrestricted access to the property. After the window to withdraw property expires (the 30-day period mentioned above), the funds would become restricted and the trust operates as the trustee intended. The Crummey provision works because the right to withdraw the funds gives the beneficiary a present interest in the property.
The obvious risk involved in setting up the Crummey trust is that during the window in which the donee is eligible to withdraw property, they may decide to do just that. In this case, the donee walks away with the property and the ultimate goal of funding the Trust would not have been accomplished.
Crummey trusts are a great estate and gift tax planning tool, but there are many things to consider before establishing one. If you are interested in exploring the benefits of Crummey trusts and understanding the complex matters associated with them, please feel free to contact your L&B professional at (858) 558-9200.