Crummey Notifications: The Ultimate Guide to Form 709
Are notices required? Or, are we instead asking the wrong question?
This is a continuation of the series on preparing Form 709. For the first article in this series and a series index, click here.
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Table of Contents
Intro and Recap
The last few articles in this series have analyzed the specific types of Crummey withdrawal rights we often encounter, along with the tax and accounting principles behind each. However, the technical side of withdrawal rights is not the start or end point. The broader issue tends to be the notice procedure behind Crummey withdrawal rights.
On this point, many practitioners are split. Conservatively, written notices of withdrawal rights should be given by a donor/settlor to both the trustee, and each beneficiary holding a withdrawal right. Frequency of notification tends to be a concern, as some practitioners believe a one-time notice for recurring Crummey gifts is sufficient. In many cases, the notification process is not overseen by an attorney, which leaves settlors and trustees to draft these documents on their own. As a result, advisors or family offices are often left to create retroactive Crummey notices.
The question of whether or not Form 709 is filed continues to be a concern as well. Technically, if all gifts are below the annual exclusion for a calendar year (and no gift-splitting election is filed), then no 709 is required to be filed. As discussed for certain Crummey powers such as hanging powers and 2514(e) powers, filing a 709 to allocate GST tax exemption can be a good idea – especially if automatic allocation is not certain or there is a question of accurate accounting for timely allocations. But, this creates a chicken-and-egg scenario. How?
If there is no valid Crummey power, then a 709 is required due to the existence of a future interest gift. In other words, a future interest transfer of any amount invokes the requirement to file Form 709. There may also be retroactive automatic allocation of GST exemption after 2000, so long as the trust in question is a GST trust not subject to an ETIP. What role does the Crummey notification play here? Does a lack of a timely Crummey notification prevent a present interest gift, which therefore invokes a gift tax filing requirement? And, even if a gift tax return is filed, must timely Crummey notifications be completed and filed with the return?
Let’s take a survey of the current landscape of issues. By no means is this intended to be a complete summary of all authority out there, but I have cherry-picked some of the most frequently-cited cases and rulings to illustrate the current landscape.
Crummey v. Commissioner
Contrary to popular belief, the oft-cited 9th Circuit decision in Crummey v. Commissioner, 397 F.2d 82 (1968), is not the foundation for the treatment of withdrawal rights as present interests in general. Such a dynamic predates this decision, and was respected by both the IRS and Tax Court under Crummey with respect to a beneficiary who had reached the age of majority at the time the withdrawal right was granted. Instead, Crummey revolved around the ability of a minor beneficiary to meaningfully exercise a withdrawal right due to state-law limitations on a minor’s ability to own and contract for property.
Ultimately, the Court in Crummey reached the conclusion that a withdrawal right granted to a minor did, indeed, qualify as a present interest gift so long as the exercise of the right could not be resisted by the trustee by virtue of the child’s legal disability of minority. In other words, if a guardian was not appointed at the time of the withdrawal right, this would not prevent the immediate possession or enjoyment of property transferred to the trust subject to the withdrawal right. It was not the facts and circumstances surrounding the likelihood of exercise or non-exercise that controlled – it was instead just the lack of impediments under bare legal rights that mattered.
As a result, for example, if the trust or applicable law allowed a parent or guardian to exercise the right on the child’s behalf, it would be respected as a present interest gift. The IRS subsequently acquiesced to this position in Rev. Rul. 73-505, in the process revoking Rev. Rul. 54-91 (which had previously treated all gifts to minors as future interests if no guardian was actually appointed at the time of the gift).
Later, in Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), the Tax Court further analyzed Crummey to conclude that withdrawal rights are not restricted to those beneficiaries holding a vested present or remainder interest in the trust itself. While Cristofani doesn’t necessarily go to the extreme of saying you can give anyone under the sun a withdrawal right under a trust, it does support the creation of withdrawal rights for remainder beneficiaries (vested or contingent) so long as the other requirements with respect to such rights (discussed as follows) are granted.
Which brings us to the IRS view on Crummey rights.
Rev. Rul. 81-7
The IRS, after Crummey and Cristofani, shifted focus from bare legal impediments to immediate possession, use or enjoyment (the prerequisite for a present interest) to more of the procedural limitations surrounding withdrawal rights. In Rev. Rul. 81-7, the IRS concluded that the donor’s conduct before and after the creation of a withdrawal right could render such right “illusory” if a donee holding a withdrawal right did not have a “reasonable” opportunity to both learn of, and exercise, a withdrawal right before it lapses.
This is often cited as a written notice requirement, but the Ruling does not go that far. It simply notes that the donor’s intent matters, and that this intent can be gleaned from facts and circumstances. In the Ruling, a trust was created on December 29, and the donee had until December 31 to exercise the withdrawal right – which the donee did not receive notice of from the donor. In the eyes of the IRS, these combined facts meant the donor “did not intend to give the donee a present interest.”
If we pull on this thread, we see that there is no express written notice requirement. Something like an oral notice, or even an e-mail, could suffice so long as it gives the donee a “reasonable” opportunity to exercise the withdrawal right. However, the IRS still views the requirement to give notice as an indispensable requirement. See, for example, PLR 200123034 (requiring “prompt notice” from the trustee for the creation of a present interest).
We also see the potential for the grantor, or trustee, to provide the notice. Generally, the terms of the trust that create the withdrawal right specify who is required to provide notice. Modern trusts typically impose that requirement on the trustee – but one must wonder whether the shift of responsibility from the grantor to the trustee can create a delay and, consequentially, a meaningful impediment to the creation of a present interest?
In this vein, we see a split in how the Tax Court treats Crummey rights under a trust.
Turner v. Commissioner
The Tax Court case of Estate of Turner v. Commissioner, T.C. Memo 2011-209, mostly deals with contributions to a family partnership being included in the deceased contributor’s gross estate under IRC Section 2036. However, despite the thorough thrashing on the 2036 issue, the Tax Court throws the taxpayer a bone when it comes to Crummey rights.
The withdrawal right portion of this case involved use of the decedent’s personal assets, and partnership assets (treated as owned by decedent under 2036), to directly pay premiums on a life insurance policy owned by an ILIT. While beneficiaries of the ILIT held withdrawal rights, the IRS argued that the indirect contribution to the policy itself instead of the trust prevented the beneficiaries from having a present interest. The IRS further argued it was this indirect gift, along with the lack of notice to trust beneficiaries, that rendered the withdrawal rights under the ILIT illusory.
However, the Tax Court relied solely upon the lines of reasoning in Crummey and Cristofani to focus on legal impediments as the primary determinant for the existence of a present interest. In its reasoning, the Tax Court noted:
The fact that [Decedent] did not transfer money directly to [Decedent’s] trust is irrelevant. Likewise, 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.
Unlike Crummey and Cristofani, the IRS has not yet acquiesced to the dispensation of the notice requirement as seemingly-condoned by Turner. Instead, the presence or absence of a prearranged plan under the facts and circumstances to prevent the exercise of withdrawal rights now appears to the core focus of the IRS. Subsequent arguments by the IRS have looked at broader facts and circumstances relating to present interests.
(Before moving on from Turner, interestingly there was somewhat of a retroactive gift tax argument as relates to IRC Section 2036. Since property was pulled from adjusted taxable gifts into the gross estate for gifts of partnership interests, these gifts did not impede the withdrawal rights for those same years relating to the life insurance. In other words, not only was the notice requirement dispensed, but it also appears that annual exclusions can be retroactively restored for purposes of determining the scope of present interest gifts in such prior years.)
Terms of a Trust
In Mikel v. Commissioner, T.C. Memo 2015-64, the IRS argued that the existence of a no-contest clause in a trust would itself create a bare legal impediment to a beneficiary’s exercise of a withdrawal right, because it could extend to a beneficiary’s remedies in state court to enforce the withdrawal right if the trustee refused to honor it. While the no-contest clause itself could not prevent exercise of a withdrawal right, the IRS argued that it could punish a beneficiary for doing so by allowing a trustee to forfeit the beneficiary’s discretionary interest in the trust.
However, the Tax Court noted that while the line of reasoning from Crummey and Cristofani focused on whether or not a trustee could resist the exercise of a withdrawal right, the no-contest clause only extended to decisions within the trustee’s express discretionary authority under the trust itself. Since the trustee had no discretionary authority to withhold a demand right, the Tax Court held that the no-contest clause did not create any sort of impediment to a beneficiary’s right to take state court action to enforce the demand right. It also helped that the beneficiary had the right to go before a beth din to enforce rights under the trust without forfeiting their interest.
In this line of reasoning, however, the Tax Court discussed Actions on Decision issued by the IRS in 1992 and 1996 after the Cristofani decision. The AODs noted that the IRS would henceforth focus on prearranged understandings that a withdrawal right would not be exercised, which could include (for example) terms of a trust that cause loss of other rights under the trust if a beneficiary exercises their withdrawal right. While a no-contest clause did not rise to that level, it is possible that other trust terms or trustee conduct could do so. So, for example, if a trustee made smaller subsequent discretionary distributions to a beneficiary who had previously exercised a Crummey power (when compared to beneficiaries who had allowed their powers to lapse), this could create the optics of a “prearranged understanding.”
Notably, this case (and another case cited in the decision on prearranged understandings, Estate of Kohlsaat v. Commissioner, T.C. Memo 1997-212), involved timely notifications. (Kohlsaat was basically a rejected IRS argument that the failure of any of 16 Crummey beneficiaries to exercise a withdrawal right was evidence itself of a prearranged understanding.) So, these decisions really tell us nothing about the presence or absence of notifications in any form. Instead, they show that the form of notices and withdrawal rights may not even be enough if the substantive terms of the trust itself, or trustee’s (or perhaps even donor’s) conduct, discourages or punishes a beneficiary from exercising a withdrawal right.
So Are Notices Required?
The current state of Crummey notices is one of seemingly-divided guidance. On one hand, we have a focus by the IRS on a “prearranged” plan or understanding to in substance deprive a withdrawal right that is granted in form – of which notice or lack thereof seems to still be the starting point (but perhaps not the sole determinant). On the other hand, we have Tax Court decisions which appear to support that notice does not matter, especially if there is no other evidence that the withdrawal rights were illusory.
It is easy to look at Turner, and conclude that no notices are required – after all, the Tax Court expressly stated this – but facts and circumstances continue to matter. The Tax Court noted that the ILIT in Turner created an “absolute right and power” to demand withdrawals when there was a “direct or indirect” transfer to the trust. The ages of beneficiaries also were not cited, but the decedent’s age at death (83 or 84) supports a conclusion that all of the children and grandchildren holding withdrawal rights were perhaps adults for the years in question. While the question of whether a Crummey power holder is a minor or an adult is not necessarily determinative for notice purposes (the beneficiary in Rev. Rul. 81-7 was an adult), perhaps an adult child having knowledge of a parent’s general planning (as opposed to a child, who would lack such knowledge) is material in implying the existence of a constructive notice of withdrawal rights.
Which brings us to a point that is often overlooked – terms of a trust matter. If the trust requires written notices, then a failure to provide written notices is a breach of the trust. This is especially exacerbated when it is the grantor, or a family member (as trustee), who has the responsibility under the trust to provide notice as a failure to do so implies a general intent not to comply with the terms of the trust. Failing to follow a trust is perhaps the greatest foundational argument of substance-over-form, which the IRS can latch onto as evidence of a prearranged plan to deprive withdrawal rights.
Ultimately, all this boils down to optics. The more you can do to build evidence that withdrawal rights are meaningful, the better the optics. Written, timely Crummey notices are perhaps the easiest proof – but are they the best proof? Written Crummey notices are not time-stamped. They can be dated, but dates can be backfilled. (In fact, I believe that the vast majority of written Crummey notices are now created after the actual transfers that create the Crummey rights – a trend that I’m sure has not been ignored by the IRS.)
Perhaps a more significant fact, however, is timing of transfers, as there must be both a meaningful notice period and a meaningful withdrawal period. For example, any transfer made in December will have a short withdrawal period if the withdrawal right expires on December 31 – an outcome that (as we have previously discussed) is often implied under the terms of IRC Section 2514(e) as applied to all types of Crummey rights. The earlier in the year a transfer occurs, the stronger the evidence of a meaningful notice and exercise period. Two days is not enough, but as noted in Cristofani, 15 days is enough.
However, while not expressly stated, notice in the various authorities cited above can perhaps be equated with “knowledge.” Anybody who is trained in law recognizes that notice is hard to prove, so the law presents constructive or implied notice in a variety of circumstances. Knowing about the terms of a trust that grant a withdrawal right may be enough, as it alerts a beneficiary to the fact that they should be inquiring about transfers to the trust periodically – after all, it is simply the lack of a legal impediment that controls instead of a beneficiary’s failure to inquire about or defend their rights. So, perhaps just a copy of the trust, or an initial set of Crummey notices, would suffice without the need to continually create new notices every time there is a transfer to the trust. Of course, if a grantor does not want their beneficiaries to know about the existence of a trust (i.e., a “blind trust”), it is difficult to fathom how the grantor could meaningfully create present interest transfers to that trust.
What’s Next?
This is not the end of the road for Crummey notices. Unfortunately, the existence of present interests are so facts-and-circumstances driven that it is impossible to give you a binary test based on notifications or lack thereof. Even with timely Crummey notices, it is possible that no annual exclusion will be granted.
And, as I noted above, this is not a comprehensive analysis of all authority. There are several other cases, PLRs, and other rulings and determinations that come into play. As it stands, however, this is a topic that I’m sure is of interest to a broad set of my readers. If that includes you, as I teased out Over the last couple of weeks, I am working on developing continuing education webinars. Before the end of the year, either as a stand-alone webinar or as part of a broader mini-symposium, I plan to include a survey of Crummey rights. The survey will dive into deeper issues – such as whether interests in a business entity might be future interests. Please stay tuned for more.