The United States Tax Court has issued a stunning decision regarding the notice requirement for present interest gifts. As discussed in the December 2010 Newsletter, a present interest gift is one in which the beneficiary has an immediate, unrestricted right to the use, benefit, and enjoyment of the gifted property. When making such gifts through a Trust, the best practice is for the giftor to make a gift to the Trust. The Trustee should then notify the beneficiaries that a gift has been made and that they have a right to withdraw their portion of the gift within a stated time period (“Crummey” notice). After the time period has passed, the trustee may invest the assets, often by paying the premium on a life insurance policy owned by the Trust.
In Estate of Clyde W. Turner, Sr. v. Commissioner (United States Tax Court, T.C. Memo. 2011-209), the decedent had established an Irrevocable Life Insurance Trust during his life for the benefit of his children and grandchildren. The 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. Rather than following the best practice as stated above, the decedent paid the life insurance premiums directly to the insurance provider and failed to give notice to the beneficiaries.
Surprisingly, the U.S. Tax Court disagreed with the Internal Revenue Service’s argument that the beneficiaries’ withdrawal rights were illusory because the decedent did not deposit money with the trustees first but instead paid the life insurance premiums directly and because the beneficiaries did not receive notice of the transfers. Instead of determining that the gifts were future interest gifts as most practitioners would have expected, the Court held that (a) the fact that the giftor did not transfer money directly to the Trust is irrelevant and (b) the fact 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.
While this surprising decision provides some flexibility to giftors and trustees that fail to follow the established practices for making present interest gifts by way of a Trust, it is strongly recommended that when making such gifts, proper procedure be followed so that, when the time comes for the IRS to analyze the transfers, there is no question that the transfers constituted present interest gifts and are therefore excluded from the giftor’s taxable estate.