The Crummey Notice Requirement – What is the Point and When is it Necessary?

Posted By: Manish C. Bhatia

One of the primary techniques used to reduce a person’s taxable estate is making gifts during his or her life to other individuals, usually children or grandchildren, using the annual gift tax exemption ($14,000 in 2017). An individual can make a gift up to the exemption amount to as many people as he or she wants in the given year. The exemption expires on December 31st and then the next year’s exemption begins on January 1st.

In other words, if Thomas wants to make gifts of $14,000 to each of his ten grandchildren, he could reduce his taxable estate by $140,000 each year. However, Thomas will most likely want to retain some sort of control over the gifts—such as if a grandchild is not yet mature enough to handle large amounts of money, has a drug or alcohol addiction, has creditor issues or has a divorce pending.

To accomplish these goals, Thomas can place restrictions on the use of the gifts by establishing an irrevocable Gift Trust or an Irrevocable Life Insurance Trust (“ILIT”) and making the gifts to the trust rather than to the beneficiaries outright. The trustee will then administer the trust as provided by Thomas in the trust document. Such trusts are irrevocable and, therefore, require significant thought and consideration of whether the creator of the trust (the “grantor”) is willing to part with the assets and under what terms he or she wishes to make the gifts.

Present Interest Gift

In order for a gift to qualify as a gift for purposes of being removed from the grantor’s estate, it must be a present interest gift. 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.

If Thomas gives his son, Smith, $5,000 and Smith can use it now, it is a gift of a present interest. If Smith is not entitled to such benefits, then the gift is considered a future interest. An example of a future interest would be if Thomas established a trust for the benefit or Smith and made a gift to such trust without granting Smith a right to withdraw the gift immediately. Such a gift would not be considered a present interest gift and would thus be included in Thomas’s taxable estate upon his death.

The Notice Requirement

The IRS requires that the grantor follow established procedures for payment and notice in order for the transfer to be considered a present interest gift. For example, assume that Thomas establishes an ILIT for the benefit of his grandchildren. The intention is that by establishing the ILIT to own the life insurance policy, the proceeds of the policy at Thomas’s death, along with the premiums that are paid during his life, will be outside of Thomas’ taxable estate at his death.

In order for this goal to be accomplished, the process for making the gifts and paying the premiums must be as follows. First, Thomas must make the gift (the amount of premium due) to a bank account established by the trustee of the ILIT. Second, notice must be given to the beneficiaries of the ILIT in the form of “Crummey Notices” (named after the case establishing the requirement) stating (a) that a gift has been made to the ILIT, (b) that the beneficiary is entitled to withdraw the amount stated in the trust document, and (c) the date by which such withdrawal must be made. Third, the trustee may pay the premium to the insurance provider. Only by following these steps can the grantor properly make a present interest gift that will be excluded from his or her taxable estate.

An issue that is far too common arises when the trust is established but the trustee fails to ensure that the necessary procedures are being followed on an annual basis—for example, the grantor makes the premium payment directly from his personal bank account to the insurance company or the trustee fails to send notice to the beneficiaries that a gift has been made. Such a failure or shortcut can result in significant gift tax consequences and essentially eliminate the benefits that the grantor intended to achieve by establishing the ILIT in the first place.

It is critical that the attorney communicate and the grantor understand the requirements of maintaining an irrevocable trust so that the intended goals can be accomplished. An affordable and efficient solution is to have the preparing attorney maintain the irrevocable trust by making sure that the annual notices are prepared and sent in a timely manner. Since the attorney is familiar with the goals and intentions of the grantor as well as the personal situations of the beneficiaries, this is often the best way to ensure that the proper procedures are followed. When done properly, the irrevocable trust can be an invaluable tool for reducing estate and gift tax liability.