Using Crummey Trust for Tax Free Gifts to Children

There are very tax efficient ways to pass wealth from a parent to a child when there are potential estate tax considerations.

 

Using Crummey Trust for Tax Free Gifts to Children

Oftentimes inter-generational wealth is passed by amounts not exceeding the gift tax exclusion limit. Many parents and grandparents make their annual gifts to a custodial account under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). These laws will be different in each state. It is important to check if a state follows UGMA or UTMA, but this information on the accounts will generally be correct.

 

What is a UGMA and UTMA account?

An UGMA or UTMA account works well and is easy to create and maintain. These are creations of state laws and most states have this option available for their residents. However, using UGMA or UTMA accounts have one major defect: when the child (or grandchild) reaches age 18 or 21, depending on the state in which the beneficiary resides, the beneficiary can do whatever he or she wants with the money in his or her custodial account. For example. the child could take the money and go on a big vacation instead of spending it on their college education.

 

What is a Crummey Trust?

Most parents do not want their children to have unfettered access to money when they turn 18 or 21. Fortunately, there is a special kind of trust that avoids this problem. It’s called a “Crummey” trust, after a court case that paved the way for the use of this kind of trust. This is an estate planning technique that can be employed to take advantage of the gift tax exclusion when transferring money and/or assets to another person, while placing limitations on when the recipient can access the money.

 

Why use a Crummey Trust?

With a Crummey trust, the property can remain in trust for as long as you wish without forfeiting the gift tax annual exclusion. Thus, you can transfer property to remain in a Crummey trust for the beneficiary’s entire lifetime or until an appropriate age (e.g., age 30) or event (e.g., graduation from college). You decide how the money is to be used and how much the beneficiary can receive.

 

Annual Contributions Crummey Trust

Annual contributions you make to the Crummey trust won’t qualify for the gift tax annual exclusion unless you notify the beneficiary that you’ve made the contributions, and give him or her a limited period of time (usually 30 days) in which he or she can withdraw the contributions from the trust. It’s usually understood that the beneficiary won’t exercise his or her right to withdraw the contributions, but will let them remain in the trust.

 

Special Considerations on using a Crummey Trust

However, that expectation should always remain unwritten because, if there’s any evidence of it, IRS will use that evidence to say that the beneficiary didn’t really have a power of withdrawal. If the beneficiary violates the unwritten understanding by withdrawing property from the trust, there’s nothing you can do about it, except to show your displeasure by not making any further contributions to that beneficiary’s trust.

Gift Tax Exclusion Explanation

In addition to income taxes, there are also gift taxes that taxpayers with higher amounts of assets must become familiar with. Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees through the proper use of their gift-tax exclusions. The statutory exclusion amount ($10,000) is adjusted for inflation annually, using 1997 as the base year. The amount of the exclusion for 2013 and 2014 is $14,000.

 

What is the Annual Gift Tax Exclusion?

The exclusion covers gifts an individual makes to eachdonee each year. The donnee is the receiver of the ift.  Thus, a taxpayer with three children can transfer a total of $42,000 to them every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $14,000, the exclusion covers the first $14,000 and only the excess is taxable and will reduce the lifetime gift tax exemption. Further, even taxable gifts may result in no gift tax liability thanks to the unified credit.

 

Gift-splitting by married taxpayers (Gift Tax Exclusion Example)

If the donor of the gift is married, gifts to donees made during a year can be treated as split between the husband and wife, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $28,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available for them to use. Thus, for example, a married couple with three married children can transfer a total of $168,000 each year to their children and the children’s spouses ($28,000 for each of six donees).

Gift Splitting and Gift Tax Exclusion

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Because more than $14,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $28,000 exclusion covers total gifts.

 

The “present interest” requirement

For a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the donee’s enjoyment of the gift can’t be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while he’s alive and donee B is to receive the principal at A’s death, B’s interest is a “future interest.” Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $14,000 of its total value will not be taxed. However, the gift of the other interest (called a “remainder” interest) is a taxable gift in its entirety.

 

Exception to present interest rule

If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements (called Code Sec. 2503(c) trusts because of the section in the Internal Revenue Code that permits them) allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

 

“Unified” credit for taxable gifts

Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $5,250,000 (for 2013). However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.