In “A Not-So-Crummey Way to Avoid Taxes: A Call for Congressional Action to Eliminate Abuse of the Present Interest Requirement,” Kristin L. Zook makes an interesting contribution to the existing catalogue of suggested reforms to the annual gift tax exclusion's present interest requirement. At the same time, she provides a useful history of the development of the scope of the exclusion and of the definition of present interest.

The annual gift tax exclusion permits a donor to make annual gifts of up to $13,000 to unlimited numbers of individuals.1 The only requirement is that the gifts consist of present interests in property. Congress permitted the annual exclusion in 1932 “to obviate the necessity of keeping an account of and reporting numerous small gifts. . . [such as] wedding and Christmas gifts and occasional gifts of relatively small amounts.”2 But the statutory language used to describe the exclusion extends its coverage far beyond the relatively narrow class of gifts that Congress intended to protect. Case law has extended the class of protected gifts to virtually all gifts made in trust to the extent that donees have a present power to withdraw the gifted property from the trust. The exclusion protects such gifts even if the withdrawal right lasts for only a limited period of time and even if there's little possibility that the power holders will actually exercise their withdrawal powers.3

The availability of the annual exclusion for gifts to trusts has made the annual exclusion the foundation of many estate plans. An individual who has a large number of relatives and friends to whom she is willing to give a temporary withdrawal right can protect hundreds of thousands of dollars worth of gifts from the gift tax each year even though the intended beneficiaries of those gifts may be a much smaller group of individuals. Arguably, gifts of this sort abuse the annual exclusion and may significantly erode the transfer tax base.

Over the years, many individuals and groups interested in transfer tax reform have targeted the annual exclusion. Suggested reforms have included:

  • limiting the aggregate amount of yearly exclusions to a fixed dollar amount such as $25,000;4

  • requiring that the power of withdrawal over gifts made in trust last until the death of the donee;5

  • allowing the annual exclusion for gifts made in trust only if they meet the requirements of IRC Section 2642(c), the generation-skipping transfer tax equivalent of the annual gift tax exclusion, which requires single beneficiary trusts that (a) prohibit distributions to anyone other than the beneficiary during her life and (b) contain a provision that will cause any remaining trust property to be subject to estate tax at the beneficiary's death;

  • allowing the annual exclusion for gifts in trust subject to withdrawal power only if the power holders have significant beneficial interests in the trust or if (a) there is no arrangement or understanding to the effect that the powers will not be exercised and (b) there exists at the time of the creation of such powers a meaningful possibility that they will be exercised.6

Endnotes

Zook's goal is a reform proposal that would preserve the effective use of discretionary or sprinkle trusts. Obviously, a change in the definition of present interest to require single beneficiary trusts or non-lapsing withdrawal rights, a common feature of many existing reform proposals, would inhibit the use of inter vivos trusts that give trustees the right to decide which beneficiaries will receive trust distributions. Many estate planners suggest granting this kind of flexibility to give trustees the power to tailor actual distributions to the future circumstances of beneficiaries.

Zook proposes a “wait and see” approach. A donor who makes gifts subject to withdrawal powers to a trust would initially be permitted the same annual exclusions that would have been available to her if she had made outright gifts to the individuals holding the withdrawal powers. If, however, one or more of the power holders receives more than her share of the initial gift amount, the donor would be required to file an amended gift tax return reporting the excess as a taxable gift not subject to the exclusion. There's also a suggestion that amended gift tax returns would be required to report amounts that were subject to withdrawal powers but were not withdrawn.

This proposal is an appealing one, but needs some more thought about how it would actually operate. Property contributed to a trust is generally not retained indefinitely in the form in which the trustee receives it. Such property may be invested, may generate investment income, and may be exchanged for other property. Because the property is not maintained in its original form, it would be difficult to determine if a $15,000 distribution to one beneficiary represented a part of the property that was originally subject to another beneficiary's withdrawal power or represented a combination of the property the beneficiary who received the distribution could have withdrawn plus investment income. Because the donor's death may precede the full distribution of the original gifted amounts, the proposal also includes a requirement that donees who receive excessive distributions after the conclusion of the administration of the donor's estate must file amended gift tax returns on behalf of the donor. This approach is likely to be complicated for the trustees and donees and difficult to enforce.

Hopefully the author will continue to develop her very intriguing idea. The generation of fresh ideas, such as this one, to deal with the potentially abusive use of the annual exclusion, will be instrumental in achieving a pattern of reform that is acceptable both to the Internal Revenue Service and potential donors.

  1. The annual exclusion amount for gifts made after 1998 is adjusted for inflation from an initial $10,000 amount. Internal Revenue Code Section 2503(b)(2). The adjusted amount for 2009 is $13,000. Revenue Procedure 2008-66, 2008-45 IRB.
  2. H.R. Rep. No. 72-708 (1932); S. Rep. No. 72-665 (1932).
  3. See, for example, Crummey v. Commissioner, 397 F. 2d 82 (9th Cir. 1968); Cristofani v. Comm'r, 97 T.C. 74 (1991).
  4. David Brockway, “Comprehensive Estate and Gift Tax Reform,” 95 TNT 32-26, Feb. 16, 1995.
  5. 87 TNT 125-40 Description of Possible Options to Increase Revenues (JCS-17-87). Joint Committee on Taxation's List of Revenue Options and Revenue Estimates Relating to the Fiscal 1988 Federal Budget, June 25, 1987.
  6. Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures (JCS-02-05), Jan. 27, 2005

Reviewer: CARLYN S. MCCAFFREY is a New York-based partner and head of the Trusts and Estates department of Weil Gotshal & Manges LLP. She's also a member of the Trusts & Estates advisory committee on estate planning & taxation