Generation-Skipping Transfer Tax Effects of Crummey Withdrawal Rights

Cutting through the noise when it comes to hanging powers and other types of withdrawal rights

Executive Summary: The treatment of Crummey powers post-lapse affects the GST tax treatment of the powers. So long as the lapse is limited to the greater of $5,000 or 5% limitation, the creator of the Crummey power will be treated as the transferor for GST tax purposes - even though the unlapsed portion may be subject to gift/estate tax with respect to the power holder in the future. But, the question of whether the transferor actually needs to allocate their own GST tax exemption depends on the treatment of the unlapsed portion (i.e., over $5,000 or 5%) of the Crummey withdrawal right in the hands of the power holder.

If this unlapsed portion is isolated to a separate trust share, for which (1) the Crummey power holder is the sole income and principal beneficiary for life and (2) the income and principal will be included in the power holder’s gross estate at death, then the trust is assigned a zero inclusion ratio and is thus GST-exempt. If the power holder is a skip person, this is accomplished by treating transfers as direct skips with a zero inclusion ratio by virtue of the trust itself being a skip person under IRC 2642(c) and Treas. Reg. 26.2612-1(f), Example 3. If the powerholder is not a skip person, this is by virtue of the gift tax annual exclusion amount being excluded from the denominator of the applicable fraction in determining the trust’s inclusion ratio as set forth in Treas. Reg. 26.2642-1(c)(3).

But, if the cumulative, unlapsed portion of a Crummey power (over the $5,000/5% lapse limitation) is held in a common trust for multiple current income/principal beneficiaries (often called a “hanging” power”), the transfers to the trust are indirect skips under Treas. Reg. 26.2612-1(f), Example 3 and IRC 2642(c)(2). In such a case, GST exemption would have to be allocated to transfers subject to a Crummey withdrawal right - even if some or all powers are held by non-skip persons - creating a mismatch between the taxable gift portion of the transfer and the amount of GST exemption which must be allocated in order to maintain a zero inclusion ratio.

In the following video, I discussed the basic and intermediate differences between five by five withdrawal rights, and Crummey withdrawal rights, from a gift and estate tax perspective.

But, to close the loop on this video, I skimmed one issue - the treatment of Crummey powers from a perspective of the generation-skipping transfer (GST) tax. This is an issue that has confused many practitioners, and while there are several articles on this topic, many are incomplete in their analysis.

To preface, my goal here is not necessarily to be “complete,” but to add more guidance that is often not considered.

With that being said, in the video, I discussed two types of Crummey powers. One form, which I will refer to as a “2642(c)(2) trust” in this article, isolates contributions and withdrawal rights to a separate share trust for each Crummey power holder, over which the holder is the sole lifetime income/principal beneficiary and over which the holder retains (usually a limited) testamentary power of appointment. The other form, colloquially called “hanging powers,” uses a common trust fund approach under which all Crummey beneficiaries may exercise their rights of withdrawal from the same pool of assets, but over which Crummey powers can only lapse by $5,000 (initially) per holder. The excess difference between this lapse amount, and the gift tax annual exclusion, “hangs” in the form of a cumulative withdrawal right which carries over to the next year and lapses incrementally on an annual basis by the greater of $5,000, or 5% of the cumulative power.

From an accounting and administrative perspective, the difference between the two types of Crummey powers lies in who can benefit. While a cumulative hanging power remains unsatisfied, a distribution to another beneficiary could cause (1) a completed gift from the Crummey power holder to that beneficiary, and (2) the use of that Crummey power holder’s own GST tax exemption if the distribution recipient is a skip person. However, in the case of a 2642(c)(2) trust, this is never an issue because one cannot incur gift/GST tax on a “gift” to themselves.

As we will find out as well, there is a mismatch from a GST tax perspective as to how the two Crummey powers are treated. For one type of power, the use of the gift tax annual exclusion will create a corresponding GST tax exemption. For the other type of power, the gift tax exclusion will not, by itself, create any relief from the GST tax.

GST Tax, in General

In this context, it is important to consider what elements of GST tax that are involved. On a high level, GST tax applies or is avoided by the use of the GST tax exemption, which can be automatically or manually allocated to both lifetime transfers and transfers at death. For lifetime transfers, GST tax exemption is usually only allocated to the portion of a transfer which (1) represents a taxable gift, and (2) for which there is GST potential. GST potential is determined based on the present or future existence of beneficiaries who may be skip persons, even if the potential is remote. GST potential is also indirectly based on the likelihood that a non-skip person may in the future be treated as the “transferor” for GST tax purposes, usually through the retention of a power or interest that could cause that non-skip person to be subject to the gift or estate tax with respect to the transfer.

In the latter case, where it is likely that a non-skip person will be a future transferor, it may not make sense for the current transferor to allocate their own GST tax exemption. Why? Because the gift/estate tax event that shifts the future identity of the transferor will wipe the slate clean on any prior allocation of GST tax exemption. At that point, maintaining GST exempt status (through allocation of sufficient GST exemption to create an inclusion ratio of zero) will require the new transferor to allocate their own GST tax exemption, based on the gift/estate tax value of the assets at that time.

Given these principles, we can see where Crummey powers may cause issues. Such powers are, as noted in the video, lifetime general powers of appointment. Unlapsed Crummey powers held at death are testamentary general powers of appointment. The lifetime exercise (in favor of someone else), or release or lapse of the powers in excess of $5,000 (or if greater, 5%), in either case creates an indirect gift which causes the power holder to become the new transferor for GST tax purposes. Cumulative powers have the same effect at the death of the power holder, but without the allowance of the $5,000/5% lapse exclusion. In either case, there is a potential that the power holder will have to allocate their own GST tax exemption, most likely at death. This will be important if the power holder predeceases the original creator of the Crummey power, which will cause such original creator to essentially waste GST exemption if they made any prior automatic or manual allocations.

But, we cannot predict order of death, and in most cases we can assume that the Crummey power holders will have a longer life expectancy than the creator of that power. So, creating a GST-exempt trust (to the extent such creator’s GST exemption is sufficient) can be paramount. Otherwise, you run the risk of GST tax at a rate of greater than 0% if a skip person benefits from the trust at some point in the future.

In this vein, the GST tax treatment of Crummey powers can be extremely confusing.

A Helpful Example

As I will cite in this article, there are a number of helpful examples in the Treasury Regulations relating to this issue.

The first relates to the issue I just mentioned - the identity of the transferor shifting when a Crummey power lapses. What we find out is that only a lapse in excess of the greater of $5,000, or 5%, changes the transferor. As noted in Treas. Reg. 26.2652-1(a)(5), Example 5:

T transfers $10,000 to a new trust providing that the trust income is to be paid to T's child, C, for C's life and, on the death of C, the trust principal is to be paid to T's grandchild, GC. The trustee has discretion to distribute principal for GC's benefit during C's lifetime. C has a right to withdraw $10,000 from the trust for a 60-day period following the transfer. Thereafter, the power lapses. C does not exercise the withdrawal right. The transfer by T is subject to Federal gift tax because a gift tax is imposed under section 2501(a) (without regard to exemptions, exclusions, deductions, and credits) and, thus, T is treated as having transferred the entire $10,000 to the trust. On the lapse of the withdrawal right, C becomes a transferor to the extent C is treated as having made a completed transfer for purposes of chapter 12. Therefore, except to the extent that the amount with respect to which the power of withdrawal lapses exceeds the greater of $5,000 or 5% of the value of the trust property, T remains the transferor of the trust property for purposes of chapter 13.

This is helpful, because the general rule of IRC Section 2652 shifts the transferor before taking into account any exemptions, exclusions, deductions, and credits. Since the transferor shift itself can wipe clean the original transferor’s allocation of GST exemption, we need the exception of the 5 by 5 lapse exclusion to have any hope of certainty when it comes to allocation of GST tax exemption.

The Example also gives some comfort when it comes to a trust relying on a 2642(c)(2) structure. Since, in the Example, the Crummey holder only becomes the transferor to the extent there is a “completed transfer” for purposes of Chapter 12, it allows us to invoke the incomplete transfer structure condoned by Treas. Reg. 25.2511-2(b) under which a deemed transfer is not complete for gift tax purposes so long as the donor retains a testamentary power of appointment.

So, what does all this mean? It means that the effects of allocating GST exemption can be isolated to the settlor of a trust who makes a transfer subject to a Crummey power, so long as the lapse is limited to $5,000 or, if greater (as would be the case for a cumulative hanging Crummey power valued at over $100,000 after several years of accumulations), 5% of the total amount that could be withdrawn under all cumulative, unlapsed Crummey powers.

It also means that in either Crummey structure - whether we have 2642(c)(2) trusts, or hanging powers - that the $5,000 or 5% could lapse into a trust structure for beneficiaries other than the Crummey power holder, without either an indirect gift or an allocation of the Crummey holder’s GST exemption.

Direct or Indirect Skip?

Recall that creator of a Crummey power gets a gift tax annual exclusion, assuming all of the traditional requirements relating to notice to the power holder and meaningful access to the contribution by the power holder are preserved. But, does this also qualify for a GST tax annual exclusion?

In this vein, there is often confusion - first around the rules of a GST tax annual exclusion, and second around the classification of a Crummey power itself as either a direct skip or indirect skip.

To start, there is no express GST tax annual exclusion. Instead, IRC 2642(c) creates a general presumption that gifts qualifying for the gift tax annual exclusion will be given a zero inclusion ratio. But, this exclusion only applies to direct skips. And, unfortunately, most transfers to multi-generational trusts will not qualify as direct skips. (Note that we focus solely on direct skips because GST tax would not apply to a direct transfer to a non-skip person.)

Given our transferor-shift rules above, it seems like a transfer subject to a Crummey power would be classified as a direct skip depending on the identity of the actual power holder themselves as a skip person or non-skip person. After all, such a transfer is tantamount to an outright gift to the power holder, at least from a gift and estate tax perspective. But, as we will find out, that is not the case when it comes to the GST tax - it is still, in essence, treated as a transfer to a trust.

In order for a transfer in trust to be a direct skip, the trust itself must be classified as a skip person. The requirements for a trust to so qualify can be found in Treas. Reg. 26.2612-1. If we look to Treas. Reg. 26.2612-1(d), it notes that a trust is generally a skip person if only skip persons hold the interests in the trust.

Given that requirement, it can seem nigh impossible for a multi-generational trust to be classified as a skip person. But, there is some good news. The next section of the Regulation - Treas. Reg. 26.2612-1(e) - incorporates IRC Section 2652(c), which limits the definition of an “interest” in trust to only those persons having a present or current right (whether mandatory or discretionary) to receive distributions of income or principal. In the Code (but not Regulation) definition, future interests (such as remainders) are expressly excluded from being interests in trust for GST tax purposes.

In other words, we need only look to the current beneficiaries. But, if any non-skip persons are current beneficiaries, this means the trust itself cannot be a skip person, the transfer cannot be a direct skip, and ultimately the transfer can’t qualify for the GST tax annual exclusion. Indeed, as we find out in Treas. Reg. 26.2612-1(f), Example 3, the mere existence of a non-skip income beneficiary messes everything up by keeping the trust from being a skip person:

T transfers $50,000 to a new trust providing that trust income is to be paid to T's child, C, for life and, on C's death, the trust principal is to be paid to T's descendants. Under the terms of the trust, T grants four grandchildren the right to withdraw $10,000 from the trust for a 60 day period following the transfer. Since C, who is not a skip person, has an interest in the trust, the trust is not a skip person. T's transfer to the trust is not a direct skip.

Even having the grandchildren as current income (instead of remainder) beneficiaries in this Example likely would not have helped, because Treas. Reg. 26.2612-1(d)(2)(i) requires all interests to be held by skip persons. In essence, this means the default treatment is that transfers to a trust subject to Crummey powers will be indirect skips for GST tax purposes, even if exempt from gift tax by the gift tax annual exclusion. We will circle back to that general rule below, and examine how that affects the allocation of GST tax exemption.

But, what if we didn’t have a common trust for multiple beneficiaries? In other words, if the trust were divided into separate shares, some for living non-skip beneficiaries with an interest and others for living skip beneficiaries with an interest, could the separate share trusts for the skip persons potentially themselves (at the trust level) be skip persons? If so, that would be optimal, because that could allow transfers to these trusts to be direct skips qualifying for the GST tax annual exclusion.

Alternatively, what if there was a common trust, but the only beneficiaries (and Crummey power holders) were skip persons?

There is both good news and bad news in this vein. By the technical definitions in IRC Section 2612 and its Regulations, the trust solely for one or more skip persons could itself be a skip person. But, under IRC Section 2642(c), this is not enough. Indeed, as alluded to above, IRC Section 2642(c)(2) imposes additional requirements on transfers in trust. I have already highlighted the basic requirements for this trust - use of a separate share trust for one beneficiary who is a skip person, coupled with gross estate inclusion at that beneficiary’s death. Notably, this Code Section itself does not expressly require the trust to be a skip person, but it does invoke IRC Section 2642(c)(1) which only applies to direct skips. So, we can infer that this rule would only apply to skip person trusts.

So, this means that as long as we use a 2642(c)(2) trust for skip persons, the trust itself would be a skip person and, ergo, the creator of the Crummey power could qualify for the GST tax annual exclusion. As a result, such creator would not have to allocate any of their GST exemption to the skip person’s Crummey power (since the portion of the transfer qualifying for the gift tax annual exclusion is given a zero inclusion ratio under IRC Section 2642(c)). And, the gift to the trust (and not the skip person - an important distinction) would be reported on Schedule A, Part 2 of Form 709 as a direct skip.

But, what does this mean for Crummey powers granted to non-skip persons through a 2642(c)(2) trust? In a twist of irony, there is no way for these transfers to qualify for the GST tax annual exclusions under our sets of definitions above, because they are not direct skips. And, while the death of the non-skip Crummey power holder could result in the eventual allocation of that power holder’s own GST exemption, what happens to the lapse portion of $5,000 or 5% that could benefit skip persons each year during the power holder’s life? Indeed, we know by the fifth Example from Treas. Reg. 26.2652-1(a)(5) that the creator of the Crummey power is still the transferor of that lapsed portion. So, if the lapsed portion passes from the non-skip person’s 2642(c)(2) separate share trust into a common pool for both skip and non-skip persons, would it require allocation of the power creator’s GST exemption? After all, there is no reason for this lapsed portion to stay in the separate share trust.

As we will find out below, there is an alternate way to get there - which invokes a separate definition of the inclusion ratio of such a trust for a non-skip person.

But, when we refer back to Treas. Reg. 26.2612-1(f), Example 3 above, hanging powers in a trust with any current interest held by a non-skip person will be created as indirect skips, which require allocation of GST exemption (at least to the lapsed portion) in order to remain GST exempt. But, all of this raises an important question. In such a case, should GST exemption be allocated to the entire annual exclusion gift, or just to the lapsed portion that is returned to the “general population” of trust assets?

GST Exemption Allocation

For my next act, I will have you turn your attention to the allocation rules for the GST exemption.

It is often considered that lifetime GST exemption allocation goes hand-in-hand with taxable gifts, but that is not necessarily the case. Instead, IRC 2632 generally allows GST exemption to the allocated in an amount up to, but not to exceed, the amount necessary to create a zero inclusion ratio. This allocation is made on a per-year basis, first to direct skips and then to indirect skips.

To understand this zero inclusion ratio concept, we must turn to IRC Section 2642(a), which defines the inclusion ratio as (1 - applicable fraction), and defines the applicable fraction as the exemption allocated over the value of the transfer. This Code Section reduces the value of the transfer (in the denominator) by any estate tax paid from it, as well as the gift/estate tax charitable deduction, but it does not mention the gift tax annual exclusion. (The marital deduction is not included here for reasons we will discuss below regarding ETIPs.)

Instead, to get to the gift tax annual exclusion, we have to go to Treas. Reg. 26.2642-1(c). This Regulation adds some color, clarifying that “nontaxable transfers” need not be included in the denominator of the applicable fraction. In general, nontaxable transfers are those that qualify for the gift tax annual exclusion, but with the same exception as for direct skip trusts highlighted above - that transfers in trust must be to a trust that meets the same requirements as a 2642(c)(2) trust. But, notably, this Code Section (and the corresponding direct skip requirement) is not referenced - instead the same requirements (for the structure of a qualifying trust) are expressly restated with the same potential outcome of a zero inclusion ratio.

It is here that perhaps there is a glimmer of hope - that a Crummey power within a 2642(c)(2) trust given to a non-skip person could still be given a zero inclusion ratio without the need to allocate GST exemption to get there. In such a case, we are able to avoid the issue of a “leak” of the lapse portion, and the corresponding need to allocate GST exemption, discussed above. Unfortunately, the examples in this Regulation only describe direct skip trust situations, so there is no direct clarification on this point.

First, we see in Treas. Reg. 26.2642-1(d), Example 2:

On December 1, 1996, T transfers $10,000 to an irrevocable trust for the benefit of T's grandchild, GC. GC possesses a right to withdraw any contributions to the trust such that the entire transfer qualifies for the annual exclusion under section 2503(b). Under the terms of the trust, the income is to be paid to GC for 10 years or until GC's prior death. Upon the expiration of GC's income interest, the trust principal is payable to GC or GC's estate. The transfer to the trust is a direct skip. T made no prior gifts to or for the benefit of GC during 1996. The entire $10,000 transfer is a nontaxable transfer. For purposes of computing the tax on the direct skip, the denominator of the applicable fraction is zero, and thus, the inclusion ratio is zero.

Next, in Example 3, we add in a gift above and beyond the withdrawal right:

T transfers $12,000 to an irrevocable trust for the benefit of T's grandchild, GC. Under the terms of the trust, the income is to be paid to GC for 10 years or until GC's prior death. Upon the expiration of GC's income interest, the trust principal is payable to GC or GC's estate. Further, GC has the right to withdraw $10,000 of any contribution to the trust such that $10,000 of the transfer qualifies for the annual exclusion under section 2503(b). The amount of the nontaxable transfer is $10,000. Solely for purposes of computing the tax on the direct skip, T's transfer is divided into two portions. One portion is equal to the amount of the nontaxable transfer ($10,000) and has a zero inclusion ratio; the other portion is $2,000 ($12,000 − $10,000). With respect to the $2,000 portion, the denominator of the applicable fraction is $2,000. Assuming that T has sufficient GST exemption available, the numerator of the applicable fraction is $2,000 (unless T elects to have the automatic allocation provisions not apply). Thus, assuming T does not elect to have the automatic allocation not apply, the applicable fraction is one ($2,000/$2,000 = 1) and the inclusion ratio is zero (1 − 1 = 0).

Given the long storied history of practitioners not allocating GST exemption to the lapse “leak” from the indirect-skip versions of 2642(c)(2) trusts, perhaps we are safe to assume that this leak does not require allocation of GST exemption. But, these transfers may need to be reported on Schedule A, Part 3 of Form 709 depending on the presence of other taxable gifts for the year and the choice of GST exemption allocation.

So, we do get clarification here that a transfer to any other form of trust not meeting the one lifetime beneficiary/gross estate inclusion requirements will not get the benefit of excluding a “nontaxable portion” from the denominator of the applicable fraction. The result is that transfers structured as hanging Crummey powers will include the annual exclusion portion in the denominator of the applicable fraction, meaning that GST exemption must be applied to the hanging Crummey powers at least in part in order to maintain a zero inclusion ratio.

So, we must circle back to the question of GST exemption allocation, and timing.

Automatic Allocation Rules

Regardless of whether a gift tax return is filed, (and indeed, gift tax returns often are not filed for Crummey gifts), it is possible that GST exemption could be allocated to a transfer under the automatic allocation rules found in IRC Section 2632 and Treas. Reg. 26.2632-1. These rules only apply, however, if there is no action taken on Form 709 to change this default, automatic allocation treatment. If elected, there are parts of Form 709 which allow you to specify how GST exemption will be allocated to a qualifying transfer, or perhaps to “turn off” the automatic allocation rules for current year or even future transfers.

Now, I must warn you that I will somewhat oversimplify this analysis (even though my lack of brevity may indicate otherwise), but I bring that up to say that there are several fact-specific threads that can derail the general treatment of automatic or manual allocations of GST exemption.

Recall above our analysis about whether transfers to create Crummey rights constitute direct skips, or indirect skips? This is somewhat important, because GST exemption is allocated first to direct skips occurring during a calendar year and next to indirect skips occurring during the same calendar year. But, it is somewhat of a moot point for the direct skip transfers we discussed (to a qualifying 2642(c)(2) trust), as in either case the Regulations contain a fail-safe in that GST exemption can only be allocated to the extent needed to create a zero inclusion ratio. Since the separate share trusts classified as skip persons above are given a zero inclusion ratio automatically, this means no GST exemption can be allocated.

But, in the case of separate share trusts for non-skip persons described in Treas. Reg. 26.2642-1(c), we have to get granular in determining the denominator of the applicable fraction. These are not direct skips, but instead indirect skips. Likewise, hanging powers for both skip persons and non-skip persons would be indirect skips, since the definition of direct skip is determined at the trust level even where Crummey powers are involved.

What is the significance of an indirect skip? It is our ticket to entry for automatic allocation. So long as the trust involved meets the requirements to be a “GST trust,” it will qualify for automatic allocation. Even if the trust is not a GST trust, however, GST exemption can still be allocated - either by a manual allocation for each transfer to the trust, or by an election to treat the trust as a GST trust (thereby allowing it to qualify for automatic allocation for current-year and future transfers).

Conveniently, a Crummey power itself does not keep a trust from qualifying as a GST trust. The closing paragraph of IRC Section 2632(c)(3) clarifies this. However, there is one form of Crummey power that can be risky in this regard - a spousal Crummey power. Why? Because it can create an estate tax inclusion period, or ETIP.

An ETIP, in short, is a period during which all or any part of the trust could be included in the gross estate of the transferor, or transferor’s spouse (other than by reason of IRC Section 2035), if either were to die.

The significance of an ETIP is that it defers the timing of GST exemption allocation. The general outcome is that an ETIP defers the actual occurrence of an indirect skip until the close of the ETIP. But, at the close of the ETIP, the automatic allocation rules apply at that time. The catch is that the automatic allocation is based on the value of the trust assets at the close of the ETIP. So, best practice is often to elect out of automatic allocation on Form 709 - either in the year of the initial transfer creating a trust subject to an ETIP, or in the year the ETIP terminates.

What does this have to do with Crummey powers? In short, it means a spousal Crummey power can create an ETIP. And notably, under Treas. Reg. 26.2632-1(c)(iii), if any part of a trust is subject to an ETIP, the entire trust will be subject to the ETIP. So, in the worst case, a spousal Crummey power can disqualify the entire trust from allocation of GST exemption until, at least, all of the spouse’s Crummey rights have lapsed.

There is, however, a workaround. Treas. Reg. 26.2632-1(c)(iii)(2)(ii)(B) clarifies that a spouse’s withdrawal right will not create an ETIP so long as the withdrawal right itself is limited to the greater of $5,000 or 5% of the trust assets, and so long as the withdrawal right lapses no later than 60 days after the transfer to the trust.

So, with hanging powers, any Crummey right granted to a spouse usually should be limited to $5,000 - it is rare that the greater 5% limitation would apply with respect to the transfer itself. And, it is not likely that a spousal hanging Crummey power would qualify for the QTIP election under IRC 2523. As a result, a reverse QTIP election cannot be made with respect to the Crummey power under IRC 2652(a)(3).

With respect to non-spousal hanging powers, it is a common recommendation to allocate GST exemption to the entire amount which could be withdrawn. This could be accomplished using either the automatic allocation rules or manual allocation, but for manual allocation Form 709 would have to be filed. (I will not be making a recommendation as to the allocation method to be used.)

But, this raises an interesting question. Going back to our GST exemption “leak” theory above, recall that Treas. Reg. 26.2652-1(a)(5), Example 5 treats the original Crummey power creator as the transferor of the lapsed portion that does not exceed the $5,000/5% lapse limitation. A lapse in excess of that amount shifts the identity of the transferor to the holder of the Crummey power, since that excess lapse is a completed gift of a future interest (at least in part) to the other trust beneficiaries. Such a lapse could be an estate tax transfer, probably classified as an indirect skip, at the death of the holder of the Crummey power as well.

Given this risk, is an allocation of GST exemption in excess of the lapse limitation (usually $5,000) essentially wasted?

Keep in mind, as we noted above, that the Crummey power itself does not cause the trust to be disqualified from automatic allocation (by virtue of disqualification as a GST trust) so long as this is the only potentially disqualifying factor. (If there are other disqualifying factors, the trust can elect to be treated as a GST trust, which will invoke automatic allocation for the year of the election and for indirect skip transfers in all years after.)

But, this is where our timing issue comes in as well. Keep in mind the first example cited above - Treas. Reg. 26.2652-1(a)(5), Example 5. This Regulation makes clear that there is no transferor shift unless there is a lapse in excess of the $5,000/5% limitation. So, the creator of the Crummey power remains the transferor of the entire hanging power - both the lapsed portion, and the cumulative unlapsed portion. And, if we assume that assets appreciate in value for perpetuity, the most bang for the buck will be gleaned from having the Crummey power creator allocate their GST exemption out of the gate to the entire Crummey power, instead of leaving it up to the Crummey power holder to allocate their own at future (presumably higher) values of trust assets.

I suppose, however, that if one were so motivated, they could make the case of only allocating GST exemption to the lapsed portion of a cumulative withdrawal right each year in a situation where GST exemption may be sparse. The issue is that one cannot rely on automatic allocation for just this lapse portion. So, a 709 would be required each year to specify (1) that there is an election out of automatic allocation for the current-year transfer, (2) GST exemption is allocated at the time of lapse, and not the time of the original gift, (3) the GST exemption allocation is limited to the greater of $5,000, or 5% of the lapsed portion of the cumulative Crummey power, and (2) that there is also an election out of automatic allocation for future transfers that cause accretion of the cumulative hanging Crummey power.

In other words, I see no way to use this method without an annual 709 filing, since automatic allocation is always based on the time of the gift and not the time of the lapse. So, even if possible, this method may not be administratively or economically feasible and is perhaps too prone to mistakes.

Conclusion

Ultimately, the fact that “present interest” remains largely undefined by statute leads to this mismatch. Where a Crummey power is involved, we have competing sets of instructions - one under IRC 2503(b), and the other under IRC 2642(c), which drive our analysis where transfers to trusts are involved. What’s worse is that these competing sets of instructions run contrary to what makes sense - that gift and GST tax exclusions should perfectly interact without exception. (I did not even address the state law creditor protection headaches that can arise where Crummey powers are involved - a topic that can be even more difficult to nail down.)

In the world of tax reporting, this can cause several headaches. Not only is one charged with knowing how to interpret the structure of Crummey powers (for which there are options which even extend beyond the two common types discussed in this article) and compliance with the procedures for adequately creating and documenting such powers, but one must also rely on forensic analysis of cash in versus cash out at the trust level to determine the results (usually after the fact).

This is made worse, for example, in the case of an ILIT where there may not even be a gift to the trust. In a situation where the premium is paid directly by the insured (or if different, the grantor of the trust), we may have no Crummey power and worse, no automatic allocation of GST exemption to the premium transfer. In such a case, the best outcome we could hope for is late allocation of GST exemption - an exercise that is much more complicated than it seems at first glance in this situation.

To continue this thread, in the future I hope to expand a bit more on how to account for both types of Crummey powers, along with gift tax reporting principles on Form 709.