Dear Clients and Friends,
When setting up trusts for children, grandchildren and other family members, one has a greater ability to limit the beneficiaries’ right to challenge trustees’ decisions in court as a result of a 2016 U.S. Tax Court decision.
Here’s the background: A person can gift up to $15,000 per year to any other person(s) without incurring a federal gift tax. This rule will not generally apply if one places the money into a trust for a beneficiary. The argument is that one is not giving the named beneficiary – in legal terms – a “present interest” in the funds making any such gift potentially taxable.
The challenge now becomes: How can one avoid gift taxes while still having one’s gifts protected in a trust for beneficiaries who are minors or otherwise unable to take responsibility for gifted monies? A common solution is to put the gifted funds into a trust and provide in the trust terms that the beneficiary(ies) shall have 30 days in which to withdraw them.
Typically, beneficiaries will not withdraw the money and possibly jeopardize their likelihood of receiving further gifts and under these circumstances (an unrestricted 30-day window to withdraw) the beneficiary is deemed to have a “present interest” in the funds and said gift(s) are therefore exempt from the gift tax.
A trust set up in this manner is referred to as a “Crummey trust,” after D. Clifford Crummey, a Methodist minister who pioneered the idea back in the 1960s.
The new case referred to above involved Erna and Israel Mikel, a New York couple who over time transferred more than $3 million to a Crummey trust to benefit some 60 relatives.
The trust documents said the beneficiaries could withdraw the money within 30 days (which no one did). The documents also gave detailed instructions for how and when the trustee could distribute funds to the beneficiaries over time, such as to help them pay for a wedding, buy a house, or get started in a profession.
Apparently the Mikels were concerned to prevent squabbles and lawsuits within the family, because they added a clause saying that if any beneficiary were to go to court to challenge a trustee’s decision, that beneficiary would be cut off and could get nothing further from the trust.
That’s when the IRS pounced. According to the IRS, this “don’t-go-to-court” provision invalidated the entire plan because it meant the beneficiaries didn’t really have a “present interest” in the funds. They argued, if beneficiaries demanded their money within 30 days and the trustees said no, the beneficiaries would be out of luck because they couldn’t file a lawsuit.
But the Tax Court sided with the Mikels. It said the “don’t-go-to-court” provision didn’t apply to a request to withdraw the money within 30 days; it applied only to future decisions by the trustees over whether to pay for a wedding, a house, tuition, etc.
This ruling remains as good news if you want to create a trust for your family but also make it less likely that your family members will later fight among themselves.
Note: While the federal government lost this battle, some states do place their own restrictions on certain types of “don’t- go-to-court” provisions.
We continue to invite each of you to contact us for a free phone evaluation regarding any of your estate planning questions of concerns.
Best,
Ron