A Crummey Trust, named after the 1968 court case, Crummey v. Commissioner, 25 TCM (CCH) 772, gives a grantor the ability to transfer assets to beneficiaries, (usually minor children) in a way that allows the grantor to maintain some control while avoiding gift and estate tax. Usually a grantor funds this type of trust by transferring an amount into the trust up to the annual gift exclusion ($14,000/year in 2017). By transferring this money, the grantor can remove this amount from their estate, and avoid having to file a gift tax return. The trustee will often use the transferred funds to pay premiums for a life insurance policy owned by the trust, increasing the amount eventually transferred to the beneficiaries. This type of trust gets around rules that, for a gift to qualify for the annual gift exclusion, it must be of a present interest. Having a present interest means that the recipient has an immediate right to use the asset and has full control over it. This is as opposed to a future right to the assets.
A Crummy Trust is an irrevocable trust. If done correctly, the assets in the trust will not be included in the grantor’s estate for the purpose of calculating estate tax. The mechanisms by which this is done are Crummy Notice and Crummy Powers. A Crummy Notice is also known as a Crummy withdrawal right. This is an annual notice given to a beneficiary or their guardian that says that the beneficiary has some time, usually less than 30 days, but no more than 60 days to use their Crummy Power and withdraw the gift. If the beneficiary or their guardian does not exercise this power, the assets remain in the trust.
The IRS only allows this trust to operate if there is no agreement in place that stops the gift recipient from exercising their Crummy Power. If such an agreement exists, the IRS considers the Crummy Powers to be a sham and thus the gifts are not of a present interest, and they do not qualify for the annual exclusion. To avoid the beneficiary claiming the gift, the beneficiary is told that if a gift is claimed, then the trust will not be funded in the future.
By gifting to a trust, the grantor can put restrictions on the use of the assets in the trust, as well as create ages where the money will be transferred to the beneficiary outright. This technique allows a wealthy family to remove a large amount of money out of their estate without it being subject to gift or estate tax. If two parents with one child created a Crummey Trust when a child was born and funded the trust with the maximum of $28,000 ($14,000 each parent) for 18 years, they would have removed $504,000 from their taxable estate. This can be done for multiple beneficiaries if the grantor wishes.
Estate Tax Consequences
New Jersey starts collecting estate taxes on estates where more than $675,000 is transferred to someone other than the surviving spouse. The top estate tax rate in NJ is 16% and applies to the entire amount transferred. A fully funded Crummey Trust, as described, can lower your NJ estate tax bill by $80,640.
New York has decided to match their exclusion amount to the federal exclusion amount by 2019. In 2017, the New York exemption is $5.25 million and the federal exemption is $5.49 million. Like NJ, NY has a top estate tax rate of 16% and, if you transfer more than 105% of the exemption, the entire amount transferred is taxed by the state. While the NY estate tax applies to a much lower percentage of the population than NJ, if it applies to you, a fully funded Crummey Trust, as described, can lower your NY estate tax bill by $80,640.
The federal estate tax is different from the state level estate tax in two significant ways: the top tax rate is much higher, at 40%, and tax is assessed only the amount transferred above the exemption amount, rather than from dollar one. Again, the federal estate tax applies to very few people, but if it applies to you, a Crummey Trust, funded as described, can lower your estate tax bill by $201,600.
These types of trusts can be very valuable, but they can often be quite complicated. There are a host of issues that can come into play when drafting, funding and administering these types of trusts. For example, if your trust has multiple beneficiaries then you will have to worry about IRC§2514(e) which contains a 5x5 limit. This limit says that if a general power of appointment lapses (the person does not exercise their power to take the gift) then any part of the gift greater than the larger of 5% of the trust or $5000 is treated as a gift to the other beneficiaries. This gift to the other beneficiaries is of a future interest, and so it does not qualify under the annual exclusion. There are ways of avoiding this as well, including using a hanging powers of appointment until the trust assets are large enough. An attorney who knows the tax code, and who knows trust law can create a Crummy Trust that can help keep a significant amount of money in your family.