Perhaps no estate-planning tool is more subject to the law of unintended consequences than the ubiquitous Crummey1 power. But, although there can be estate, gift and generation-skipping transfer (GST) tax consequences, it's the income tax impact that is most often overlooked. In some cases, these surprises do not become apparent until later, perhaps when a question arises regarding a trust's qualification as a subchapter S shareholder.

Simply put, a Crummey power is a general power of appointment. A powerholder has, at least temporarily, the right to the property subject to that power. Once that power has been released, assuming the powerholder still has certain rights or powers over the trust, Internal Revenue Code Section 678(a)(2) will treat the powerholder as the continuing owner of the trust property for income tax purposes.2 This is true whether or not the value of the trust property will be excluded from the powerholder's gross estate;3 the powerholder is deemed to be a donor for gift tax purposes;4 and the powerholder is deemed to be the transferor for GST tax purposes.5

A close look at IRC Section 678 makes it clear that not every powerholder will be subject to income tax on the trust property subject to his withdrawal rights. First, if any of the other grantor trust provisions cause the settlor of the property to be taxed as the grantor, IRC Section 678(b) takes the powerholders off the hook. So, for example, if the donor's spouse holds the power to distribute income and principal to the beneficiaries, the donor will be taxed on the trust income.6 However, if the trustee is independent within the meaning of IRC Section 674(c), the trust income will generally not be taxed to the donor.7

Also, the powerholder must retain such rights in the trust that would cause the powerholder to be treated as the grantor if he had originally transferred the property to the trust. In a typical family trust, when the powerholders are the primary beneficiaries of the trust, this is not an issue that requires much analysis. IRC Section 677(a)(1) or (2) would cause almost any self-settled trust to be income taxable to the donor. However, there is an exception: Section 677 is operative only if the trustee is not an adverse party8 to the trust beneficiary/powerholder. If the trustee is adverse to the beneficiary/powerholder,9 it's necessary to review the remaining grantor provisions of IRC Sections 673 through 676 to determine if the powerholder will be taxed.

The other situation in which a powerholder might not be subject to income tax is if the powerholder is only a “remote contingent beneficiary” who would not be taxed if he settled the trust personally (for example, if the only retained interest was a reversionary interest valued at less than 5 percent on the date of the gift.)10

Unless the settlor of the trust is taxed on the trust income, all or a portion of the trust's income will be taxed to the powerholder(s). If the trust is funded only with the amount that can be given without using the donor's lifetime gift-tax exemption (and no exceptions apply), then the trust is wholly grantor to the powerholder(s). If the trust was funded with more than the annual exclusion amounts, there is a portion of the trust that is not grantor and a portion that is grantor to each powerholder.

For example, consider a typical pot trust (that is to say, a trust not established with separate shares) with two beneficiaries, Michael (age 16) and Heather (age 20), each holding Crummey withdrawal rights. The parents contribute $60,000 in cash to the trust, which is invested in a mutual fund. In accordance with the trust document, the trustee (the father's uncle) sends required notices of the withdrawal rights to the beneficiaries. Because the parents expect to split the gift, thereby doubling the number of available gift tax exemptions, both of the children are notified of their right to withdraw $24,000 (or, the funds are community property so no gift-splitting would be required). After talking with their parents, neither exercises these withdrawal rights. The trustee may distribute any amount to the beneficiaries. In its first tax year, the trust earns $1,000, which is reinvested in the fund.


Assuming that there are no powers11 in the trust that would cause either of the parents to be taxed on its income, we refer to IRC Section 678(a) to prepare the tax return. This section treats as grantor any portion of a trust that is or once was under the withdrawal rights of the powerholder.

In our example, the portion of the trust subject to withdrawal by each beneficiary was $24,000/$60,000 or 40 percent each. Therefore, the portion of the $1,000 taxable income allocable to each child is $400. The remaining 20 percent ($200) is taxed under the normal trust rules of IRC subchapter J. Michael's $400 grantor portion may be taxed to his parents anyway, because he is younger than 18 and the “kiddie tax” rules of IRC Section 1(g) apply. Heather's $400 will be included in her return, probably prompting her to protest: “That's not fair — first I'm not supposed to take the money out of the trust and then I'm taxed on it anyway!” Parents (and their advisors) should be prepared.

What happens the next year, assuming that the grantor makes no additional gift transfers to the trust and the trustee distributes $15,000 to Heather in December 2007? Because the trust does not establish separate shares, Heather's distribution might logically be deemed to come equally from all three portions of the trust, leaving the percentages the same as before the distribution. (“Three portions” refers to the portion grantor to Heather, the portion grantor to Michael, and the nongrantor portion.)

If there had been separate shares, then Heather's distribution would have come from her share (that is to say, her 50 percent) of the trust. Her portion is $24,000/$30,000 (80 percent) grantor, and $6,000/$30,000 (20 percent) nongrantor. So it might be logical to assume that 80 percent of the $15,000 distribution ($12,000) would have been allocated to the grantor portion and 20 percent of the distribution ($3,000) would be charged to the nongrantor portion of the trust. If the $1,000 income were repeated in 2007, then of the $500 of income allocable to Heather's separate share trust, 20 percent would be taxed to her under the normal distributable net income (DNI) calculations of IRC Sections 661 and 662. The remaining 80 percent of the income of her separate share would be taxed to her anyway under the grantor rules. So she would pay tax on $400 as a deemed grantor, and $100 under the DNI rules of Section 662. Assume Michael received no distributions: Of the $500 of income allocable to his separate share, under the grantor trust rules, $400 would be taxed to him (or to his parents under the “kiddie tax”) and $100 would be taxed to the trust.

There are no formal rules on taxation of distributions from partially grantor trusts either with respect to the amount of income allocable to the grantor portion or the character of the income so allocated (other than the S Corporation rules). But proportionate allocation between the grantor and nongrantor portions of the trust, both with respect to total income and each class of income, is consistent with similar rules for the GST tax12 and would not be inconsistent with the limited guidance provided in the partial grantor trust regulations.13

What would the effect have been on income allocation among the grantor and nongrantor portions had the $15,000 distribution been made at the beginning of 2007 rather than at the end? Or what if additional gifts had been made during 2007? Again, there is no specific guidance. But the regulations permit “a reasonable and equitable method” to be used to calculate separate shares when unequal contributions and distributions are made in an estate.14 So it's probably safe to analogize to those regulations when allocating between grantor and nongrantor portions of a trust, other than electing small business trusts (ESBTs) holding S Corporation stock. The allocation method selected should be used consistently from year to year and well documented, because beneficiaries have been known to question the results (especially when phantom taxable income is involved).


Over the years, there have been a number of questions regarding the wording of IRC Section 678, specifically the difference between Section 678(a), which refers to the right “to the corpus or the income therefrom,” and Section 678(b), which refers to a “power over income.” This difference matters when the settlor might be taxed on trust income under IRC Section 678(b): Would he be taxed on all of the trust income, or only that taxable income allocable to trust accounting income, causing the Crummey powerholder to be taxed on the corpus gains and losses? To find out, we refer to the definitions in IRC Section 643(b). This section tells us that the word “income” in IRC subchapter J, unless preceded by another adjective, refers to trust accounting income. However, that definition does not apply to subpart E15 of subchapter J, which is the grantor trust section. In the regulations for subpart E, we are told that “income” in the subpart E regulations refers to taxable income rather than to trust income. Although this reference appears in the regs rather than in the statute, it is a strong indication that the “income” in Section 678(b) refers to taxable, not trust accounting, income. The Section 678 regulations are consistent with this interpretation: Treasury Regulations Section 1.678(a)-1(a) clearly contemplates that the settlor could be taxed on both trust accounting income and corpus transactions. Once a beneficiary has the right to withdraw corpus and allows that right to lapse, he is taxed on any future gains allocable to that corpus, and any income generated from that portion of the trust. This portion of the trust continues to be taxed to that beneficiary until the trust terminates or the beneficiary dies.16


If Heather and Michael's trust had been funded with non-dividend-paying stock in a family business, it's unlikely that anyone would have noticed or cared about the trust's partial grantor status. Only if there were a sale of the business or an election to treat the corporation as a subchapter S corporation would this issue come to the attention of the family and its advisors.

What type of trusts can be qualified S shareholders?

  1. Wholly Owned Grantor Trusts17 — Heather and Michael's trust does not qualify under this section because they are both deemed grantors under IRC Section 678(b) (and are not married to each other). Since the trust has two deemed grantors, it cannot be “wholly owned” by one grantor.

    Trusts for the benefit of a single individual that have been funded only up to the amount of the annual exclusion every year may be wholly grantor to that individual. Trusts that qualify for the GST annual exclusion18 often fall into this category. The Internal Revenue Service has, at least in private letter rulings, recognized such trusts as qualified S shareholders under the wholly owned grantor trust rule.19

    If the trust in our example were wholly grantor to the settlor under IRC Section 678(b), then it would be a qualified S shareholder (of course, the grantor would be including all the trust's tax attributes in his return). Depending on the terms of the trust, it may be possible to achieve this result by a change in trustee.20

  2. Qualified Subchapter S Trusts (QSST)21 — Heather and Michael's trust cannot qualify as a QSST because it has more than one beneficiary and it is not required to distribute all income currently. If the trust had true separate shares for each beneficiary and met all the other criteria for QSST status,22 being a partial grantor trust would not be an impediment to its QSST status.23 However, the partial grantor status must relate to the same person (or their spouse) as the named beneficiary of the QSST.24

    QSST status is often unattractive to families because of its lack of flexibility: The trust accounting income must be distributed annually, and the beneficiary is treated as the shareholder; as a result, the beneficiary is aware of the profitability of the family business.

  3. ESBT25 — Heather and Michael's trust is qualified to make an ESBT election. The ESBT regulations specifically contemplate a partially grantor trust and provide that such a trust is to be divided first into a grantor portion and a nongrantor portion. The nongrantor portion is further divided into the S portion holding the S Corporation stock, and the non-S portion holding any other assets. An ESBT election does not require annual distributions of trust income, and does not deem the beneficiary to be the shareholder; but when a partial grantor trust is involved, it cannot cure the “beneficiary information” problem. Although the S Corporation income allocated to the S portion is taxed to the trust (so the tax consequences and the related information are retained by the trust), the grantor trust portion of the income information must be provided to, and taxed to, the deemed grantor of the trust.26 There is no ordering rule affecting the allocation of tax attributes between the grantor portion and the nongrantor portion of an ESBT, so the preparer appears to be left with the “reasonable method” described in our example. Consistent with our analysis, Heather and Michael's trust was 80 percent grantor to them, so they each will be taxed on 40 percent of the income from the S shares. Income allocated to a grantor portion of an ESBT is excluded from the DNI calculation.

The remaining 20 percent of trust income is allocated between the S portion and the non-S portion of the trust. If the ESBT makes a distribution, special rules require that any distributions exhaust the DNI of the non-S portion before being sourced from the S portion of the trust.27 There are no rules regarding the allocation of distributions between the grantor and nongrantor portions of the ESBT, thereby invoking the “reasonable method” rule.28


To design estate-planning trusts without imposing unexpected taxes on the beneficiaries, consider structuring the trusts as grantor to the settlor, using IRC Section 678(b) to avoid complex reporting and family issues. Some settlors, however, are more willing to live with the reporting issues than with the phantom income. In those cases, appropriate advance planning and explanations to the beneficiaries are recommended to avoid April 15th surprises.

For those trusts that rely on IRC Section 678(b) to avoid beneficiary taxation, there is an added mystery when the settlor dies (or is no longer deemed the grantor for another reason, such as a change in trustee). Do the Crummey powerholders' rights then cause them to be taxed as the grantors? Or does the subsequent disappearance of the settlor leave the trust as a nongrantor trust? The IRS had given a taxpayer a ruling in 1990 that the powerholders' rights caused them to be taxed after the death of the grantor. Three years later, the IRS revoked and replaced that ruling with one holding the opposite conclusion: that the trust became nongrantor after the death of the settlor. There is no substantive analysis in either ruling, so all we know is that the IRS changed its mind.29 Donors and trustees should be aware of these rulings and the unsettled nature of the issue. If there is S Corporation stock involved, the trustee may want to consider an ESBT election even if the trust is believed to be a wholly grantor trust, just to assure that the S election is protected.

Whether S Corporation stock is involved or not, income tax implications of Crummey powers should not be overlooked in either document drafting or income tax reporting for trusts.

This article does not constitute tax, legal or other advice from Deloitte Tax LLP, which assumes no responsibility with respect to assessing or advising the reader as to tax, legal, or other consequences arising from the reader's particular situation.


  1. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968).
  2. Revenue Ruling 67-241, 1967-2 C.B. 225, Private Letter Ruling 200104005 (Sept. 11, 2000).
  3. Treasury Regulations Section 20.2041-3(d)(4).
  4. Treas. Regs. Section 25.2514-3(c)(4).
  5. Treas. Regs. Section 26.2652-1(a)(5), Ex. 5.
  6. Internal Revenue Code Sections 674(a), 674(d) and 672(e).
  7. The exceptions are if someone can add trust beneficiaries, or if the donor retains certain administrative rights or powers under Sections 673, 675 or 676.
  8. IRC Section 672(a).
  9. IRC Section 677(a).
  10. IRC Section 673(a) and Cristofani Estate 97 T.C. 74 (July 29, 1991).
  11. For example, administrative powers under IRC Section 675.
  12. Treasury Regs. Section 26.2654-1(a)(1)(i)
  13. Treas. Regs. Section 1.671-3, PLR 200104005 (Sept. 11, 2000) and 9034004 (May 17, 1990).
  14. Treas. Regs. Section 1.663(c)-5, Ex. 3.
  15. Treas. Regs. Section 1.671-2(b).
  16. Treas. Regs. Section 1.671-3(b)(3) and Revenue Ruling 67-241 1967-2 CB 225.
  17. IRC Section 1361(c)(2)(A)(i).
  18. IRC Section 2642(c).
  19. PLRs 9801025 (Sept. 30, 1997) and 9535047 (June 6, 1995).
  20. IRC Section 674.
  21. IRC Section 1361(d).
  22. Ibid.
  23. Treas. Regs. Section 1.1361-1(j)(3).
  24. Treas. Regs. Section 1.1361-1(j)(6)(iv).
  25. Treas. Regs. Section 1.641(c)-126. Treas. Regs. Section 1.641(c)-1(c).
  26. Treas. Regs. Section 1.641(c)-1(i).
  27. See Treas. Regs. Section 1.641(c)-1 for the complete rules for income taxation of electing small business trusts (ESBTs).
  28. PLRs 9026036 and 9321050.


Out of This World! This 78-inch model of the Starship Enterprise-D, from the television series Star Trek: The Next Generation, was estimated to sell for between $25,000 and $35,000. The final price soared to $576,000 — the highest price paid at Christie's Star Trek memorabilia auction held in New York from Oct. 5 through Oct. 7.