Crummey Power

A Crummey power is a provision in an irrevocable trust giving each named beneficiary the right, for a stated period after a contribution is made, to withdraw their share of that contribution. The right is normally never exercised; it exists so that the contribution counts as a gift of a present interest and therefore qualifies for the annual gift tax exclusion under Internal Revenue Code section 2503(b), which is $19,000 per recipient per year.

The name is unusual in that it comes from litigation rather than from the tax law. Nothing in the Internal Revenue Code or the Treasury regulations uses the word; the technique takes its name from a taxpayer who won a 1968 case in the Ninth Circuit, Crummey v. Commissioner, establishing that a withdrawal right of this kind creates a present interest. The written notice sent to beneficiaries each year is called, for the same reason, a Crummey letter.

The problem the power solves. Section 2503(b) excludes a limited amount of gifts to each recipient each year from taxable gifts, but the exclusion does not reach a gift of a future interest. Treasury Regulation 25.2503-3(a) says no part of the value of such a gift may be excluded, and defines a future interest to include "reversions, remainders, and other interests or estates, whether vested or contingent, and whether or not supported by a particular interest or estate, which are limited to commence in use, possession, or enjoyment at some future date or time." A contribution to a trust that will pay the beneficiary years from now fits that description exactly.

Paragraph (b) of the same regulation supplies the test the power is drafted to satisfy: "an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property ... is a present interest in property. An exclusion is allowable with respect to a gift of such an interest (but not in excess of the value of the interest)." The regulation's own examples make the point unforgiving. In Example (1), income the trustee may withhold at its discretion is not a present interest and no exclusion is allowed at all. Example (2) is the life-insurance case specifically: policies transferred to a trust whose income will not begin until the grantor's death are a gift of a future interest.

What the power looks like in the instrument. Each time the grantor contributes, each beneficiary named as a holder of the withdrawal right may take a stated share, usually in cash, for a defined window that is often 30 days. The right must be genuine. A right that the trustee can defeat, or that the beneficiary has no practical way of exercising, is not an "unrestricted right to the immediate use" of anything.

Why the letter exists, given that no rule requires one. Neither section 2503(b) nor Treasury Regulation 25.2503-3 mentions a notice, a letter or a delivery requirement. The practice grew up around the regulation's own language: a right the holder does not know about, and cannot exercise before it expires, is difficult to describe as unrestricted or immediate. So the standard is a dated written notice to each holder at each contribution, kept with the trust records, stating the amount, the deadline and how to make the demand. For a minor, the notice goes to the parent or guardian who would act on the child's behalf.

The lapse, which is where the mechanism bites back. When the window closes unexercised, the beneficiary has allowed a power of appointment to lapse. Section 2514(e) provides that a lapse "shall be considered a release of such power," but only to the extent the property that could have been appointed exceeds the greater of $5,000 or 5 percent of the assets out of which the lapsed power could have been satisfied. Section 2041(b)(2) says the same thing on the estate tax side. Both figures are fixed in the statute and are not adjusted for inflation, which is why the shorthand "five-and-five" has outlived several decades of price changes.

A release above that threshold has two consequences for the beneficiary, not the grantor. The released amount is treated as a transfer by the beneficiary to whoever else benefits from the trust, and because that transfer is usually a future interest to the other beneficiaries, it does not qualify for the beneficiary's own annual exclusion. And the beneficiary may end up with a slice of the trust in their own gross estate under section 2041. The standard drafting answer is a hanging power: the withdrawal right lapses each year only up to the five-and-five amount, and the unlapsed excess carries forward, hanging over the trust until later years absorb it.

Two further points. The five percent prong is measured against the assets from which the withdrawal could actually have been satisfied, so in a trust whose only asset is a life insurance policy with modest cash value that prong can be very small, leaving $5,000 as the operative figure. And a separate route exists for gifts to a minor: section 2503(c), with its own regulation at 25.2503-4, treats a gift to a trust for a person under 21 as a present interest on different conditions entirely, including that the property pass to the beneficiary at 21. It is an alternative to a Crummey power, not a companion to it.

The annual cycle, and then the arithmetic that decides whether the lapse matters.

1. The grantor makes a contribution to the trust, usually in cash and usually timed so the trustee can pay an insurance premium after the withdrawal window closes.

2. The trustee notifies each holder of a withdrawal right, in writing, stating the amount available, the deadline and how to demand it.

3. The window runs. During it the beneficiary may take the money. Nothing in the trust may prevent that.

4. The window closes. In practice nobody withdraws, and the contribution stays in the trust for its intended purpose.

5. The grantor reports the gifts. Each beneficiary's share is a present interest, so it counts against the grantor's annual exclusion for that beneficiary rather than being a taxable gift.

6. The lapse is tested against five-and-five, and any excess is treated as a release by the beneficiary.

A hypothetical, run twice. Marguerite's irrevocable trust holds a life insurance policy on her life. Her three children each hold a withdrawal right over an equal share of every contribution, exercisable for 30 days.

First year. The premium is $12,000, so Marguerite contributes that amount and each child may withdraw $4,000. The trust assets out of which a withdrawal could be satisfied are worth $80,000 at the lapse, so 5 percent of them is $4,000, and the greater of $5,000 and $4,000 is $5,000. Each child's lapsed $4,000 is below that figure, so no part of it is a release. Nobody has made a gift and nothing has entered anyone's estate.

A later year. The premium has risen and Marguerite contributes $36,000, so each child may withdraw $12,000. The assets available to satisfy a withdrawal are now worth $150,000, so 5 percent is $7,500, and the greater of $5,000 and $7,500 is $7,500. Each child's lapse therefore exceeds the safe amount by $4,500, and that $4,500 is treated as a release: a transfer by each child to the trust's other beneficiaries, of a future interest, with no annual exclusion of their own to shelter it.

A hanging power changes the second year's result. The withdrawal right lapses only to the extent of $7,500, and the remaining $4,500 stays outstanding, lapsing in a future year when that year's own five-and-five capacity is unused.

Pros

• It is the mechanism that lets contributions to an irrevocable trust use the annual gift tax exclusion, which is otherwise unavailable to them.
• The exclusion is per recipient, so a trust with several holders of withdrawal rights can absorb a substantial annual contribution without consuming any lifetime exclusion.
• The rights are almost never exercised in practice, so the trust normally keeps the money it was given.
• The drafting is standard and the annual routine is short: one contribution, one set of letters, one file note.

Cons

• The right has to be real. A beneficiary who genuinely wants to withdraw can, and a trust that quietly prevents it has no present interest to point at.
• The lapse can make the beneficiary a giver. Above the greater of $5,000 or 5 percent, the lapse is a release, is a gift by the beneficiary, and does not qualify for the beneficiary's own annual exclusion.
• It is an annual obligation for the life of the trust. A year of missed notices is a year of contributions that may not qualify.
• The five percent prong can be very small where the trust's only asset is an insurance policy, so the safe amount is often just $5,000 per holder.
• Hanging powers, the usual fix, leave withdrawal rights outstanding for years, which complicates administration and can leave a lapsed slice in a beneficiary's estate.