The Tax Court held that a husband and wife each could claim annual exclusions for gifts made to a family trust because it qualified as a Crummey trust. According to the court, a provision in the trust instrument that discouraged beneficiaries from challenging the trustees' discretionary decisions did not limit the beneficiaries' enforceable right to demand immediate possession and enjoyment of trust property.
Facts: In 2007, Israel and Erna Mikel each made a $1,631,000 gift to an irrevocable inter vivos family trust with 60 beneficiaries. The trust instrument gave each beneficiary the power to withdraw property from the trust in the year the trust was created and in any year property was added to the trust. The potential withdrawal was limited each year to an amount determined by a formula or the annual gift tax exclusion, whichever was smaller. The 2007 withdrawal amount was equal to the $12,000 annual gift exclusion.
The trust instrument also gave the trustees the power to use their sole and absolute discretion to make discretionary distributions. Any disputes concerning the appropriateness of the discretionary distributions were to be submitted for arbitration to a beth din, a panel of three persons of the Orthodox Jewish faith. The panel also was directed to give any beneficiary the rights he or she was entitled to under state law. To discourage beneficiaries from challenging the trustees' discretionary acts, an article of the trust instrument would revoke all of a beneficiary's rights if he or she challenged or opposed any distribution made by the trustees.
On their separate Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, each taxpayer claimed a $12,000 annual exclusion for a gift of a present interest to each of the 60 beneficiaries. After the Mikels each subtracted annual exclusions of $720,000, the tentative gift tax on the remaining taxable gifts of $911,000 on each return was eliminated by the unified credit. The IRS disallowed the annual exclusions, claiming the gifts were of a future interest because the beneficiaries lacked legally enforceable rights to withdraw funds from the trust. It assessed deficiencies and additions to tax totaling $336,188 against each taxpayer, who then petitioned the Tax Court and moved for partial summary judgment on the question of whether the Mikels made gifts of present interests in property that qualified for the annual exclusion.
Issues: To qualify for an annual gift exclusion, a gift must be of a present interest of property, defined as "[a]n unrestricted right to the immediate use, possession, or enjoyment of property or the income from property" (Regs. Sec. 25.2503-3(b)). Gifts to demand trusts, commonly called Crummey trusts (after Crummey, 397 F.2d 82 (9th Cir. 1968), rev'g in part T.C. Memo. 1966-144), have been held to be present interests. For the trust to qualify as a Crummey trust, whenever an addition is made to it, the beneficiaries must have the right to demand the immediate withdrawal of an amount that is tied to the maximum annual gift exclusion, and the withdrawal demand right cannot be legally resisted by the trustee.
The IRS stated in Action on Decision (AOD) 1996-10, however, that it will challenge annual exclusions for gifts to trusts with Crummey powers where the substance of the withdrawal rights do not conform with their form. According to the AOD, this will be the case where there is a prearranged understanding that the withdrawal right would not be exercised or the exercise of the withdrawal right will have adverse consequences to the beneficiary. The IRS argued in this case that no annual exclusion should be permitted because the trust instrument created adverse consequences to any beneficiary who attempted to seek legal enforcement of his or her withdrawal right, causing the withdrawal right to be "illusory."
Holding: The court rejected the IRS's argument and granted the taxpayers' motion for partial summary judgment. In reaching its conclusion, the court stated that a beneficiary who was refused a withdrawal demand could go to a beth din that would be required by the trust instrument to give the beneficiary the rights to which he or she was entitled under state law. Also, any action of a beneficiary to force the trustees to honor a withdrawal demand would not be challenging or opposing a distribution and therefore could not jeopardize the beneficiary's rights, according to the court. For these reasons, the court held that beneficiaries had no potential adverse consequences from asserting their rights and therefore had an unconditional right to withdraw property from the trust that could not be legally resisted by the trustees, that is, they had a present
- Mikel, T.C. Memo. 2015-64
—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.