Tax Free Gifts to Children & the Crummey Trust
The best estate tax planning technique is to give away assets during life. The Federal Government will tax any and all property given during life or transferred at death. However, there are a few important tax exemptions that can be used to avoid tax.
Lifetime Exemption: Before the top estate and gift tax of 40% applies, an individual is entitled to a lifetime tax credit. This credit allows each individual to transfer during life $5,340,000 of property tax free in 2014.
Annual Exemption: A gift can also be planned so that it qualifies as tax free under the annual exclusion. When the annual exclusion is used, a person’s lifetime exemption is untouched. Gifts of a present interest are tax free up to $14,000 annually to any individual. A married person, with the consent of their spouse, can gift up to $28,000, each year.
Although this annual gift concept is simple, it does take planning so that the annual gift exemption is actually used. By making gifts to each child and grandchild, a married couple can reduce their estate by hundreds of thousands of dollars each year. It is important to note that the gift does not need to be cash; it can be an interest in real property, a corporation, or intellectual property. If you have young children or grandchildren then it may be best to plan to gift to a trust rather tan the children directly. This is a common practice and usually involves using “Crummey Trust”, which is explained below. You can remember this because your children will think the plan is “crummy” because the plan ensures you stay in control.
Gifts for Tuition and Medical Expenses: In addition to the $14,000 annual exclusion, gifts to pay for educational tuition or medical expenses is also tax free without any limit. However, these gifts must be paid directly to the educational or medical provider to qualify.
Techniques to Limit Control of Gifts
Crummey Trust: A “Crummey trust,” named after D. Clifford Crummey, a taxpayer who first had this trust created, is a trust designed to accept gifts. Incidentally, D. Clifford Crummey is the second cousin, once removed, of attorney Stuart G. Schmidt.
In order for a gift to qualify for the $14,000 annual exclusion, it must be a “present interest”. This means that the beneficiary must have the immediate right to use and benefit from the gift. Absent the special characteristics of a Crummey Trust, gifts to a trust for ones future benefit will not be tax free, even if it was under $14,000. In order to meet this requirement, the Crummey Trust provides that when property is given to the trust, the beneficiary must have the right to withdraw the gift for at least 30 days. If the minor does not withdraw the gifted property, the gift property remains in the trust under the terms of the trust agreement.
The beneficiary’s right to withdraw the gifted property out of the trust is called a “crummey withdrawal power”. While the beneficiary must be given a legal right to withdraw the money, a withdrawal usually does not occur. Most beneficiaries realize that if they exercise the right, it will be contrary to your wishes, which may jeopardize future gifts.
Once the property is in the trust, the trustee can be required to use the trust property to pay for a beneficiary’s education, healthcare or general support. The trust can also specify at what age or ages the beneficiary is to receive the trust property. A common scenario is for a child to receive 50% of the trust at age 25 and 50% at age 30. However, the trust should be customized so that it fits your goals and the needs of the beneficiaries.
Custodianship: A custodianship is created by designating an adult as custodian for a minor to receive the gift under the California Uniform Transfers to Minors Act (“CUTMA”). The custodian controls the management of the gifted property and determines whether to make distributions for the minor until the minor attains age 18 (or up until age 21, provided this age is specified at the time the custodianship is created). At age 18 (or the later specified age), the minor must receive whatever property is held by the custodian. You may create a custodianship simply by transferring cash or other property to the adult as follows:
“[Adult’s name] as custodian for [Minor’s name] [Optional: until age 19 or 20 or 21] under the California Uniform Transfers to Minors Act.”
Because many banks and other financial institutions allow its customers to open custodianship accounts, this is a very easy gift giving technique. However, its simplicity also has drawbacks. First, the minor’s access to the money can only be limited to the maximum age of 21, which is often too young. Second, if the one making the gift is the named custodian on the account, the value of the account will be subject to estate tax on the donor’s death. For tax purposes the gift will be ignored and no tax planning will have been achieved. The custodian’s power to distribute the custodial property and, in effect, terminate the custodianship arrangement makes the property taxable in the custodian’s under IRC §2038. Stuit v Commissioner (7th Cir 1971) 452 F2d 190. The same result occurs if another person was the original custodian but the donor was acting in that capacity at the time of his or her death. Rev Rul 70-348, 1970-2 Cum Bull 193.
529 Account: A 529 account is a special account provided for by Internal Revenue Code Section 529; where it takes its name. These accounts are set up at financial institutions and don’t require any trust documents to be drafted. The accounts are invested in stocks and bonds by the institution and cannot be self directed. However, all earning are tax free and all distributions are tax free provided the funds are used for educational purposes.
Conclusion
The Crummey Trust is the best gifting vehicle and ensures that the tax planning goals are met. It provides almost limitless flexibility in that the trust can hold any type of property. Once the trust is set up it can continue to accept gifts from the original donor or anyone else. It is important to remember that the $14,000 ($28,000 for a married couple) exclusion amount is allowed per year per beneficiary. Therefore, to really take advantage of this annual exclusion, a gift giving program should be started early and include many individuals. After many years of using this technique, substantial tax savings can be gained, while control is maintained.
It is time to review your estate plan. If you don’t yet have an estate plan, it’s time to get it done. Your death or incapacity will be emotionally traumatic for your family; don’t make it legally difficult as well. Contact one of our estate planning attorneys , Stuart G. Schmidt or David J. Lee, to assist in the creation, review and/or update of your estate plan. Our job as your attorneys is to make this process easy and painless and, most importantly, put a proper plan in place. Call us today at (408) 356-3000 or send us an email at sschmidt@smwb.com.
