Estates, Trusts & Gifts
Under Sec. 2503(b), a donor may exclude the first $13,000 of gifts made to each donee during a calendar year in determining the total amount of gifts for that calendar year (the “gift tax annual exclusion”). For a transfer to qualify for the gift tax annual exclusion, Sec. 2503(b) requires the transfer to be a gift of a present interest. Under Regs. Sec. 25.2503-3(b), a gift of a present interest requires that the donee has an unrestricted right to the immediate use, possession, or enjoyment of property or the income from it.
In general, most transfers to trusts fail to qualify as a gift of a present interest because the donee does not have an unrestricted right to the immediate use, possession, or enjoyment of the property or the income. To have transfers to a trust qualify as gifts of present interests, and thus be eligible for the gift tax annual exclusion, the trust’s governing instrument generally contains a provision giving certain persons “withdrawal rights” with respect to transfers to the trust. A donee is usually given only a short time to exercise this withdrawal right before it lapses. This withdrawal right is drafted with the attributes acknowledged by the Ninth Circuit in Crummey, 397 F.2d 82 (9th Cir. 1968), as meeting the requirements of the gift of a present interest.
Although Crummey did not explicitly so hold, the IRS’s position is that the present-interest requirement is not satisfied (and thus, no gift tax annual exclusion is available) unless a beneficiary has actual notice of the withdrawal right and a reasonable time within which to exercise the right before its lapse. In Rev. Rul. 81-7, the IRS ruled that, if a beneficiary is not informed of the right to withdraw transfers to the trust, the beneficiary’s right to immediate possession and enjoyment of the property is postponed, and he or she effectively receives a future interest at the time the gift is made. In so ruling, the IRS said that the power to demand corpus does not qualify a transfer to a trust as a present interest eligible for the gift tax annual exclusion under Sec. 2503(b) if the donor’s conduct makes the demand right illusory and effectively deprives the donee of the power. Given this notice directive by the IRS, most trusts to which transfers are intended to qualify for the gift tax annual exclusion contain a provision in their trust instruments requiring that beneficiaries with a withdrawal power be given notice of the right to exercise this power by the trustees.
In Turner, T.C. Memo. 2011-209, the Tax Court ruled that such notice is not required. The facts in Turner pertinent to this issue were that the decedent created a trust during his life to own life insurance policies on his life for the benefit of his children and grandchildren. The trust instrument provided that, after a direct or indirect transfer to the trust, the beneficiaries of the trust had the right to withdraw the lesser of (1) the gift tax annual exclusion amount, or (2) the amount of the direct or indirect transfer divided by the number of beneficiaries. The facts do not indicate whether the trustees were required to give notice of the withdrawal power to the beneficiaries who possessed such power.
For the years in question (the three years prior to the decedent’s death), the decedent made premium payments directly to the insurance companies on life insurance policies owned by the trust. The trust instrument provided that, upon notice of a beneficiary’s exercise of his or her withdrawal power, the trustees were authorized to distribute cash or other trust property or to borrow against the cash value of any life insurance policies to obtain cash for the distribution to the requesting beneficiary.
The IRS included in the decedent’s adjusted taxable gifts the premiums paid on the life insurance policies because it concluded that the payments did not qualify for the gift tax annual exclusion. The IRS stated that the withdrawal rights were illusory for two reasons: (1) The decedent did not deposit money with the trustees but instead paid the life insurance premiums directly; and (2) the beneficiaries did not receive notice of the transfers. The Tax Court summarily dismissed both of the IRS’s arguments in one short paragraph in an otherwise very long opinion (the other issue involved the inclusion of assets in a family limited partnership in the decedent’s estate under Sec. 2036).
With regard to payment of premiums directly to the insurance company, the Tax Court (in a short sentence) said that the fact that the decedent did not transfer money directly to the trust was “irrelevant.” This conclusion seems logical, as the gift tax annual exclusion should be allowed for indirect gifts to a trust as long as the trust has sufficient assets to satisfy the withdrawal powers of beneficiaries that arise when a transfer has been made to a trust.
With regard to the lack of notice to the beneficiaries possessing withdrawal powers, the Tax Court said (again, in a short sentence) that the fact that some or all of the beneficiaries of the trust may not have known they had the power to withdraw sums from the trust “does not affect their legal right to do so.” In support of its conclusion, the court cited Crummey and Estate of Cristofani, 97 T.C. 74 (1991).
Neither Crummey nor Cristofani addressed “notice” as a requirement for a transfer to a trust subject to a withdrawal power to be a gift of a present interest qualifying for the gift tax annual exclusion. In Crummey, the issue was whether the withdrawal powers of minor children qualified as the gift of a present interest. The focus by the Ninth Circuit was on their legal right to exercise the withdrawal power. The court concluded that they did have such a right. The provision of the trust giving the beneficiaries a withdrawal power did not contain a notice requirement. The facts also reflect that the IRS had no problem with the adult children’s withdrawal powers’ qualifying for the gift tax annual exclusion.
In Cristofani, the provision in the trust instrument giving the beneficiaries withdrawal powers included a notice requirement; however, the issue before the Tax Court was whether the withdrawal powers of contingent remainder beneficiaries were present-interest gifts. Relying on Crummey, the Tax Court held that such withdrawal powers were so eligible. The facts fail to state whether the trustees satisfied the notice requirement.
The Tax Court did address a failure to give notice in Holland, T.C. Memo. 1997-302. The trust instrument said that, when a transfer was made to the trust, the trustees were immediately required to give written notice to the beneficiaries of their right to withdraw an amount up to the value of any gifts made during the year. In challenging the eligibility of the gifts to the trust for the gift tax annual exclusion, the IRS argued that the written notice requirement in the trust instrument had not been satisfied. Citing Crummy and Cristofani, the court noted that the sufficiency of notice is a factor to be considered “in the likelihood that the right of withdrawal will be exercised; it is not a factor in the legal right to demand payment from the trustee.” As to the minor beneficiaries of the trust who were the trustees’ children, the court found the failure of the trustees to give written notice to themselves did not require a finding “that the beneficiaries did not have present interests in the gifts.” As to the adult beneficiaries, the court found that, although written notice may not have been given to them, testimony at trial established that they were aware of their withdrawal rights, which gave rise to the gift of present interests.
So is Turner support for the argument that a notice requirement is not necessary for transfers to a trust subject to a withdrawal power to qualify as a present-interest gift? Does someone have a “real” right if he or she does not know that he or she has it? Apparently, the Tax Court’s answer is “yes.”
It is difficult to determine the weight of this case on the issue, given that the court gave almost no reasoning for its conclusion. The withdrawal power in Crummey had no notice requirement, but it was decided before Rev. Rul. 81-7, and it was not an issue raised by the IRS. The withdrawal power in Cristofani had a notice requirement but, again, this was not an issue. In Holland, the notice requirement was an issue, but the Tax Court determined that, based on the facts and testimony at trial, although the written notice requirements of the trust instrument had not been satisfied, the beneficiaries had notice of their withdrawal rights.
There is no doubt that the IRS will continue to argue that notice is required for a transfer to a trust subject to a withdrawal power to be eligible for the gift tax annual exclusion, and the safe course is to continue to advise clients to give notice if a gift tax annual exclusion is being claimed for a transfer to a trust. However, if the notice requirement is not satisfied regarding a particular transfer to a trust, the taxpayer now has an argument that such notice is not required.
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or firstname.lastname@example.org.
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