Hanging Crummy Powers

Technical topics regarding tax preparation.
#1
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Are hanging crummy powers unnecessary for an irrevocable trust when there is one sole present beneficiary (not multiple)?
 

#2
LW25  
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ManVsTax wrote:Are hanging crummy powers unnecessary for an irrevocable trust when there is one sole present beneficiary (not multiple)?


As you know, for purposes of Internal Revenue Code section 2503(b), a gift of a beneficial interest in a trust is considered, in general, to be a gift of a future interest, not a give of a present interest, for Federal gift tax purposes. The general rule is that a gift of a future interest made during any particular year does not qualify for the annual exclusion for Federal gift tax purposes ($15,000 for gifts made in 2020).

To make the gift instead be considered a gift of a present interest (and thus qualifying for the annual exclusion), the beneficiary should have a Crummey power (Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1986 1968). As you know, this means that the beneficiary must have the right to withdraw the gifted asset from the trust, and that the beneficiary must be aware of the right. In that situation, the gift qualifies for the 2503(b) exclusion even if the beneficiary does not exercise that right, and even if the right expires after a short period of time (such as 15 days after the making of the gift).

I'm a little rusty, but I don't think that the designation of the beneficiary as a "sole present beneficiary" somewhere has a material effect on this analysis. Instead, I think that the trust instrument needs to include the wording for an effective Crummey power for the annual exclusion to apply.

EDIT: Edited for typo on year of the Crummey decision.
Last edited by LW25 on 15-Jul-2021 9:47am, edited 1 time in total.
 

#3
LW25  
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If the gift is a gift of income that commences immediately, the gift may be considered a gift of a present interest, even without the presence of a Crummey power. Again, I'm rusty on the rules of Federal gift tax annual exclusions. As a lawyer, I had an estate and gift tax practice over 30 years ago, but that was for only a brief period, before I went back to a CPA practice.
 

#4
Anderly  
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The use of "hanging" Crummey powers is to avoid the potential for a "gift" by a beneficiary due to the release of a general power of appointment. The lapse (or release) of a power to withdraw may be a taxable gift unless the beneficiary is given a special testamentary power of appointment. Each lapse (or release) in excess of 5% or $5,000 is a release of a general power of appointment and is considered to be a transfer for purposes of §2036, causing some of the trust to be included in the beneficiary's taxable estate. If the excess over the 5% or $5,000 is "hanging" then the gift does not occur.
 

#5
Pitch78  
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Whether there is one or multiple beneficiaries is not really the issue.

This explains it pretty well. https://www.penzienlaw.com/blog/2014/fe ... -5-powers/
 

#6
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I'm a little rusty, but I don't think that the designation of the beneficiary as a "sole present beneficiary" somewhere has a material effect on this analysis.

I agree. And I don’t really know what “sole present beneficiary” means. In any case, wouldn’t we need to know more about the trust, like what might happen to the corpus in the future and who it might go to and who decides that?
 

#7
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Sorry for the delayed response. For those that remember this thread: viewtopic.php?f=8&t=19902 -- it's the same trust. I thought it would be easier to just make a new thread.

Just to recap:

--This trust involves a grandfather (trustor), son (trustee) and grandson (beneficiary).
--Every year the grandfather transfers up to the annual exclusion to the trust. The son may also choose to transfer up to the annual exclusion into the trust.
--While the beneficiary is under age 28, income may be accumulated or distributed for the grandson's benefit at the trustee's discretion. After attaining age 28, the income is to be distributed annually to the beneficiary.
--If the income is insufficient to provide for the beneficiaries care, maintenance or support, principal may be distributed at the trustee's discretion.
--A portion of principal is is be distributed after the beneficiary reaches certain ages. The last distribution of principal will occur when the beneficiary reaches age 40 and the trust will terminate.
--If the beneficiary passes away, the trust will be apportioned into shares and become part of the beneficiary's estate. Each share shall constitute a separate trust.
--It is clear this trust does indeed have crummy withdrawal powers per the trust agreement.
--I cannot find any provision in the agreement that causes the crummy powers to hang (i.e. a 5 by 5, 5 or 5, 5 and 5...etc) provision.

I am concerned that the last point might cause problems, but there is currently only one beneficiary...so I'm not totally sure.

Part of me thinks the law firm that drafted this agreement knows what it's doing (they're well paid), but I want to be sure before I ask a question.
 

#8
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This sounds more like a §678 issue. You describe a situation in which beneficiary is in effect making a gift of future interest to himself.
 

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You describe a situation in which beneficiary is in effect making a gift of future interest to himself.


Agreed. I think it would go like this: Grandpa (and maybe dad) contribute to the Trust. A Crummey Power is used to make these gifts present interest gifts. Grandchild, sole income beneficiary, doesn’t withdraw pursuant to that power, so he’s made a gift to the remaindermen…and he’s the only remainderman. He has a testamentary power of appointment.

--I cannot find any provision in the agreement that causes the crummy powers to hang (i.e. a 5 by 5, 5 or 5, 5 and 5...etc) provision.


Makes sense. You wouldn’t need a power to hang because there’s no potential gift by the bene when he failed to withdraw, as Dennis says.
 

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Forgive my ignorance...so this does not cause any income tax complications is what everyone is getting at?

In the beginning I was worried the trust might become part grantor.
 

#11
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Your use of the word “hanging” led me to believe you wanted to know about the gift tax consequences. That’s why powers hang, to avoid gifts to other beneficiaries.

In any case, yes, there could be grantor trust issues to the bene for income tax purposes. Here’s an article:

https://www.thetaxadviser.com/issues/20 ... v2014.html
 

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https://scholarlycommons.law.hofstra.ed ... cholarship

This is a good read too. Particularly pages 10-13.

I guess specifically what I'm wondering is this:

After the grantor (grandfather) contributes cash into the trust, the beneficiary is notified and the crummy withdrawal period starts. Clearly the beneficiary is a substantial owner during this period under Sec 678(a)(1) and therefore the income attributable to the contribution during this period is reportable by the beneficiary.

What happens after the crummy power lapses with respect to a specific contribution? The tax adviser article suggests that the beneficiary is still treated as substantial owner, now under Sec 678(a)(2). The article above suggests this is open to interpretation (and perhaps litigation)?

I'm trying to avoid income tax and kiddie tax consequences for the grandchild (my client's child).
 

#13
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Are the crickets because the crowd isn't quite sure, or because the poster is dumbo?
 

#14
JAD  
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I've been watching the thread. It is interesting. But I don't know. I have heard these specific issues discussed, but always as theoretical problems, that there is the chance that the IRS could take this position. I will continue to watch the thread to see what others think.
 

#15
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Thanks JAD. It seems like a real gray area based on my reading.

And in case it isn't clear...I was self-deprecating calling myself a dummy and not others. Should have said "OP" instead of poster.
 

#16
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not gray at all, although language dependent. So long as beneficiary is under age, the gift is not a contribution to trust corpus and its expiration is a non-event.
 

#17
Dennis2  
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although as mentioned earlier, the 678 issue could be grantor treatment for that proportional amount of income received from date of gift to date of expiration.
 

#18
Dennis2  
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I has been suggested that my position is incoherent. Most likely true. Beneficiary has
§678 powers over present interest gift until expiration. That means he gets a grantor letter
for the income the gift earns during that period.

The gift does not become a proportionate share of corpus. If made in cash it remains cash and beneficiary reports income
proportionate of share of cash. eg trust has 30K in cash on date of 15K gift. $45K earns $1.00 for the
period until expiration so beneficiary reports 33 cents income.

Still seems incoherent to me...♫
 

#19
JAD  
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I've read the articles linked above and have a couple of questions.

(1)

So long as beneficiary is under age, the gift is not a contribution to trust corpus and its expiration is a non-event.


Is that the effect of 678(c)? If not, where is that rule? Are you saying that the ownership of trust property and related income tax issues are not a concern until the child is 24 (assuming full time student, dependent of parents?)

(2)

If I understand, the Tax Adviser article says clearly that if the power holder is also the beneficiary, and the power holder allows the withdrawal right to lapse, the power holder/beneficiary continues to be treated as the owner of that portion of the trust after the lapse.

The Hofstra Law article discusses the issue with much less certainty.

I have a family where everyone has trusts. I prepare one of the children's returns. When he turned 35, his trust distributed to him. Until that time, he never received any reporting of any income from this trust. The trust received gifts from parents over the first 35 years.

Until age 23, shouldn't he have reported the income earned on each contribution during the withdrawal period (admittedly, an immaterial amount. I am trying to understand concepts.)

Then from 24 - 35, according to the Tax Advisor, he should have reported income earned on all subsequent gifts to the trust? Let's say maximum gift was $15,000. That's $30,000 per year for 11 years, or $330,000 by the time he turned 35. The earnings on that amount are not insignificant.

The company preparing the trust returns is a well-known, national company that has a large department that specializes in trust management and was the trustee of the trust. Have I misunderstood the concepts or is this an area of law with a low compliance rate?

How do other practitioners handle this situation?
 

#20
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This issue is complex, but usually insignificant. You can bifurcate the trust into two portions, one attributable to the grantor and one attributable to the beneficiary who did not exercise his Crummey powers. The latter is taxed as a grantor trust.

But my major concern would be that the beneficiary will take title upon reaching age 35. It may be preferable for asset protection purposes to decant into another trust which provides that at age 35 the assets are distributed to the beneficiary as trustee for his own benefit with special powers for himself to gift to others and special powers in others (e.g., his wife) to distribute assets to him.
Steve
 

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