Ever since the U.S. Court of Appeals for the Ninth Circuit issued its Crummey v. Commissioner1 ruling in 1968, the Internal Revenue Service and taxpayers have been doing battle over which gifts to trusts are present interests that qualify for the annual exclusion from gift tax. Historically, taxpayers have won these battles in the courts.
The Turner v. Comm’r2 ruling, which the Tax Court issued late last year, is significant because it’s been nearly 15 years since the Tax Court addressed this situation. The case proves that a taxpayer can win a fight with the IRS over gifts of present interests, even if the gifts are made indirectly—that is, no property is ever transferred to the trust, but the donor uses funds to pay life insurance premiums directly to an insurance company—and no notice of the gifts is ever given to beneficiaries who hold withdrawal rights.
Careful practitioners should continue to keep the IRS’ arguments in mind—which means granting withdrawal powers only to current beneficiaries of a trust and sending Crummey notices informing the beneficiaries of their withdrawal rights. But, when the inevitable “bad facts” arise, practitioners should use the pro-taxpayer holdings of Crummey, Cristofani v. Comm’r3 and Turner as the basis for negotiating with the IRS.
Before turning to the rulings and cases, let’s review the statutory rule. Internal Revenue Code Section 2503(b) provides that a donor may exclude from his total taxable gifts for the calendar year up to $13,000 given to any number of individual recipients, provided that the $13,000 gift is a gift of a present interest. Section 25.2503-3(b) of the Treasury regulations defines a present interest, in part, as “an unrestricted right to the immediate use, possession, or enjoyment of property.”
The most frequently litigated issues in the present interest context are whether notice to the beneficiaries of a contribution to a trust is required and whether it matters if the beneficiaries’ other interests in the trust (in addition to their withdrawal rights) are contingent or remote. The courts have consistently answered “no” to both questions, while the IRS has maintained the opposite view.
Notice of Gift Not Required
The seminal Crummey case, which Turner reaffirmed, says that notice of a contribution to a trust isn’t required to convert the contribution to a present interest. All that matters is that the trust beneficiaries have the legal right to demand the contributed property.
In this case, Mr. and Mrs. Crummey made gifts to a trust for the benefit of their four children, three of whom were minors. Under the terms of the trust, each child, or a minor child’s guardian, could demand up to $4,000 of the gift until Dec. 31 of the year in which the gift was made. The children didn’t otherwise have any rights to withdraw the trust property, and additional distributions were in the discretion of the trustees.
No guardian had been appointed for any minor child, and the Ninth Circuit noted that a guardian “probably never would be appointed.” Even so, the court stated that a minor could make a demand, through his natural guardian (parents), or by asking the trustees for a distribution directly, which would prompt the trustees to have a legal guardian appointed to receive the funds.
Most interestingly, the court stated that:
As a practical matter, it is likely that some, if not all, of the beneficiaries did not even know that they had any right to demand funds from the trust. They probably did not know when contributions were made to the trust or in what amounts. Even had they known, the substantial contributions were made toward the end of the year so that the time to make a demand was severely limited. Nobody had made a demand under the provision, and no distributions had been made. We think it unlikely that any demand ever would have been made.4
Nevertheless, the court held that the beneficiaries had a “right to enjoy” the transferred property, meaning that their demand, if made, couldn’t be legally resisted. As such, the court ruled that the gifts were present interests.
Revenue Ruling 81-7
With little analysis, the IRS acquiesced to Crummey in Rev. Rul. 73-405. Then, 13 years after Crummey, the IRS established its own requirement, in Rev. Rul. 81-7, that a beneficiary must be given notice of his right to withdraw trust property to qualify a gift as a present interest. The facts in the ruling are strikingly similar to those in Crummey, but produced the opposite result for the taxpayer.
The donor created and funded a trust on Dec. 29, 1979. The trust instrument granted the beneficiary, until Dec. 31, the right to withdraw up to $3,000 of any contribution made to the trust that year. Neither the donor nor the trustee notified the beneficiary of his withdrawal right. According to the IRS, these facts made the beneficiary’s withdrawal right illusory and meant that gifts to the trust didn’t qualify for the annual exclusion. This ruling staked out one aspect of its current position, namely, that a trust beneficiary must receive notice of a gift to the trust and be given sufficient time after the notice to exercise his withdrawal right (most practitioners consider 30 days to be sufficient), to create a present interest.
In 1991, 10 years after Rev. Rul. 81-7, the Tax Court issued Cristofani. This decision is significant because it holds that contingent beneficiaries who have no beneficial interest in the trust property other than withdrawal rights may, nevertheless, have a present interest and benefit from the annual exclusion under IRC Section 2503(b).
Maria Cristofani made gifts to an irrevocable trust for the primary benefit of her two adult children. During Maria’s life, the children were mandatory income beneficiaries and discretionary principal beneficiaries. They were also the trustees. Maria’s five minor grandchildren would benefit from the trust property only if Maria’s children predeceased her.
Each of the two children and five grandchildren had the right to withdraw a portion of any amounts contributed to the trust, up to the annual exclusion amount. The withdrawal rights commenced on the contribution date and lapsed 15 days later. The Tax Court didn’t comment on notice to the beneficiaries or lack thereof. (This might be explained by the fact that the adult beneficiaries were the trustees, which means that they had actual notice of the contributions and, presumably, could have exercised the withdrawal rights on behalf of themselves and their minor children.) None of the beneficiaries ever exercised their withdrawal rights.
The IRS allowed Maria’s estate to claim the annual exclusion with respect to her two children, but not her five grandchildren, on the theory that the grandchildren were only “beneficiaries of secondary importance.”
The Tax Court conceded that the grandchildren’s other interests in the trust were contingent remainder interests, but found this distinction from the facts in Crummey to be irrelevant. (In Crummey, all the trust beneficiaries could receive discretionary, present distributions, in addition to their withdrawal rights.) Simply put, the grandchildren’s withdrawal rights over the contributed property were enough to create a present interest under Section 2503(b) and Crummey. That the grandchildren’s other interests in the trust were contingent or remote didn’t change the fact that the gifts over which they had withdrawal rights were present interests.
Against the taxpayer-friendly background of Crummey and Cristofani, in 1996, the IRS issued its unfriendly Action on Decision 1996-010. In it, the IRS acquiesced to the Cristofani decision, but not its “sweeping interpretation of Crummey.” More specifically, the IRS warned that if facts and circumstances show there was a prearranged understanding that a withdrawal right wouldn’t be exercised, or that doing so would result in adverse consequences to its holder, then the gift wouldn’t constitute a bona fide gift of a present interest in property.
Soon thereafter, in 1997, the IRS issued Technical Advice Memorandum 9731004 and made good on its warning. In the TAM, the IRS ruled that withdrawal rights granted to contingent beneficiaries (being potential beneficiaries to whom income and principal would be distributed only if they survived other beneficiaries), and persons (in this case, spouses) who had no beneficial interest in the trust other than their withdrawal rights, didn’t convert gifts into present interests. The IRS ruled that the facts suggested a prearranged understanding that the contingent beneficiaries’ rights were paper rights only and that exercising them would result in unfavorable consequences.
When the Tax Court issued Kohlsatt v. Comm’r5 and Holland v. Comm’r6 a few months later, it acknowledged the IRS argument that a prearranged understanding may prevent a present interest, but declined to find such a prearrangement in either case. More specifically, the Tax Court refused to infer a prearranged understanding just because the beneficiaries were contingent (in Kohlsatt), and never exercised their withdrawal rights (in both Kohlsatt and Holland).
In ruling in favor of the taxpayers in both Kohlsatt and Holland, the Tax Court pointed out that the beneficiaries received actual notice of the donor’s contribution to the trust (even if written notice wasn’t provided as required in the trust instrument). These statements show that even the Tax Court finds actual notice of a withdrawal right to be a helpful fact. But, the recent Turner case shows that such notice isn’t necessary to prevail.
Turner Reaffirms Crummey
In 2011, the Tax Court revisited these issues in Turner v. Comm’r.7 The decision is significant for several reasons: 1) it reaffirms Crummey and Cristofani as the relevant precedents in the present interest context;
2) it holds, in line with Crummey, that notice of a gift to a trust isn’t necessary to create a present interest; and 3) it holds that indirect gifts to a trust can qualify as gifts of a present interest.
In this case, Clyde W. Turner, Sr. established an irrevocable insurance trust for the benefit of his 12 children and grandchildren. The distribution provisions of the trust aren’t detailed in the opinion; therefore, at least some of the beneficiaries could have been contingent.
The trust held three insurance policies. Clyde Sr. never transferred money into the trust to pay insurance premiums; rather, he paid the premiums directly. The trust agreement stated that, for 30 days after any direct or indirect gift to the trust, each beneficiary would have a withdrawal right up to the annual exclusion amount. The beneficiaries didn’t receive notice of the transfers.
In the Tax Court, the IRS argued that the beneficiaries’ withdrawal rights were illusory, because Clyde Sr. didn’t deposit funds into the trust, but, instead, paid the life insurance premiums directly and because the beneficiaries didn’t receive notice of the transfers. Therefore, according to the IRS, the beneficiaries had no meaningful opportunity to exercise their withdrawal rights, and the premium payments weren’t gifts of present interests.
Citing Crummey and Cristofani, the Tax Court reiterated that:
. . . in distinguishing present interests from future interests for Federal gift tax purposes, the test is not whether the beneficiary was likely to receive the present enjoyment of the property, but whether he or she had the legal right to demand it.8
Accordingly, regarding Clyde Sr.’s indirect gifts to the trust, with respect to which no notice was provided to the beneficiaries, the Tax Court held that:
The terms of Clyde Sr.’s Trust gave each of the beneficiaries the absolute right and power to demand withdrawals from the trust after each direct or indirect transfer to the trust. The fact that Clyde Sr. did not transfer money directly to Clyde Sr.’s Trust is, therefore, irrelevant. Likewise, that some or even all of the beneficiaries may not have known they had the right to demand withdrawals from the trust does not affect their legal right to do so.9
With this statement, the court concluded that the premium payments Clyde Sr. made as indirect gifts to his trust were gifts of present interests that benefitted from the annual exclusion. (See “Drafting Tip,” this page, for a practical application of Turner.)
Hotly Contested Issue
These pro-taxpayer holdings and the contrary positions taken by the IRS provide a fascinating glimpse into a hotly contested issue. Notwithstanding all its losses, the IRS continues to argue that a contribution to a trust isn’t a gift of a present interest, and, therefore, the annual exclusion isn’t available, unless the trust beneficiary is given current notice of the contribution. According to the IRS, notice must be provided after each contribution to the trust, not merely when the trust is initially funded, and the trust beneficiary must be a present income or principal beneficiary or have a vested remainder interest in the trust property, in addition to his withdrawal right.
With these IRS arguments as a backdrop, estate-planning professionals should advise their clients to continue sending Crummey notices. But, if you’re presented with an existing trust that grants withdrawal rights to contingent beneficiaries, or your client makes gifts without your knowledge and notices are never sent to the beneficiaries, don’t panic. You can successfully negotiate for your client before the IRS using the line of argument from Crummey to Turner.
1. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968).
2. Turner v. Comm’r, T.C. Memo. 2011-209 (2011).
3. Cristofani v. Comm’r, 97 T.C. 74 (1991).
4. Crummey, supra note 1 at p. 88.
5. Kohlsatt v. Comm’r, T.C. Memo. 1997-212 (1997).
6. Holland v. Comm’r, T.C. Memo. 1997-302 (1997).
7. Crummey, supra note 1 at pp. 86-87; Cristofani, supra note 3 at p. 80.
8. Turner, supra note 2 at p. 55.