Incomplete Gift Crummey Powers: The Ultimate Guide to Form 709

One GST tax-advantaged alternative to traditional hanging powers, but with risks

This is a continuation of the series on preparing Form 709. For the first article in this series and a series index, click here. For the previous article in this series, click here.

Table of Contents

1. Intro and Recap

2. Incomplete Gift Treatment

3. Trade-Offs

4. Whether to File

5. Gift Tax Reporting

6. Conclusion, and What’s Next

Intro and Recap

To preface, this article will be more theory than practical application. This is mainly because the type of Crummey power to be discussed - incomplete gift powers - may not require allocation of GST exemption. Thus, the reporting and accounting burden may not be as great unless there are other annual exclusion gifts, or taxable gifts, made in the same year.

That being said, in a prior article in this series, the structure and reporting implications of hanging Crummey powers was discussed.  To recap, the broader issue with a Crummey power is that it is a lifetime general power of appointment.  Under IRC Section 2514(e), the lapse of a (lifetime or testamentary) general power of appointment is treated as a gift to the takers in default, except to the extent the lapsed portion does not exceed the greater of (1) $5,000, or (2) 5% of the value of the assets that could have been withdrawn under the lifetime general power of appointment. 

Given that Crummey withdrawal rights are usually limited to the gift tax annual exclusion, currently $18,000 per donor, the $5,000 lapse limitation will usually apply to Crummey rights (at least initially).  So, we run the risk that up to $13,000 (offset actuarially by the amount still held in trust post-lapse for the Crummey power holder) is treated as a gift from the Crummey power holder to the other trust beneficiaries. 

To avoid a gift of this <$13,000 amount, hanging powers note that the right to withdraw the excess portion of $13,000 continues into the following calendar year.  Then, at a point no later than December 31 of the following year, another $5,000 of this Crummey withdrawal right can lapse free of gift tax – creating a carryover $8,000 withdrawal right into the third calendar year.  This repeats ad nauseum until, no later than the end of the fourth calendar year (starting from the year of the initial creation of the Crummey power), the power has completely lapsed. 

This works fine for a one-time Crummey power.  But, where there will be an annual gifting program, this outcome may not be ideal. 

Effectively, with hanging powers, the excess (unlapsed) portion of every annual gift adds to the cumulative amount that can be withdrawn.  This can create uncertainty if, for example, the principal subject to withdrawal is needed for other trust purposes (like payment of life insurance premiums in an ILIT) because the trustee must preserve principal for satisfaction of all cumulative withdrawal rights.  It can also create issues in determining the tax status of the trust, as the Crummey power holder will be treated as the income tax owner of the cumulative principal that can be withdrawn under the grantor trust rules if the grantor is not the deemed income tax owner.  (Ironically, this grantor trust status with respect to a beneficiary could avoid Kenan gain under IRC Section 663(a)(1) and Treas. Reg. 1.661(a)-2(f) if the power is satisfied with appreciated, non-cash assets.)

At some point, the cumulative hanging withdrawal right could exceed $100,000 – thus availing the beneficiary of the higher 5% lapse limitation under IRC Section 2514(e) until the unlapsed cumulative right falls back below $100,000.  But, knowing when and how to determine this inflection point requires precise accounting and valuation. 

And, as discussed in the prior articles on this subject, the hanging Crummey power is treated as an indirect skip for GST tax purposes.  The outcome is that GST exemption should be allocated to the entire Crummey power by the donor, because the lapse of the Crummey power does not change the “transferor” for GST tax purposes from the donor to the holder of the Crummey power.  Unlike direct skips of annual exclusion amounts, an indirect skip usually is not granted a GST tax “annual exclusion.”

Given these issues, what if there was a workaround?  Is there a way we can create a bit more certainty as to the use of the principal allocated to the excess, unlapsed Crummey power?  Is there a way we can avoid allocating GST exemption, even though we are not required to use gift tax lifetime credit? 

There is, under a combination of authorities - IRC Section 2642(c)(2), and Treas. Reg. 25.2511-2(b).  We will call this the “incomplete gift Crummey power” for purposes of this article series.