“Crummey” Powers

Crummey powers (named after a man named Crummey whose successful lawsuit validated the technique) are used in connection with Irrevocable Life Insurance Trusts (ILITs) in order to have gifts to the trust qualify for the gift tax annual exclusion. The exclusion is currently $12,000 per donor per donee per year and is indexed for inflation. Only gifts of a “present interest” qualify for the exclusion, and, without Crummey powers, gifts to an ILIT would otherwise be deemed to be gifts of a “future interest”, since the very essence of a trust is to defer enjoyment of the property in the trust until some future time.

Crummey powers need to be carefully drafted and implemented, and we here at Provada are intimately familiar with exactly what is needed in order to make them fully effective. The holders of Crummey powers are typically the primary beneficiaries of a trust, but sometimes these powers need to be given to secondary beneficiaries as well in order to have enough annual exclusions to cover the full life insurance premiums. This can be accomplished by following the “Cristofani” guidelines (Cristofani was another successful taxpayer), and also requires careful drafting and implementation. We are also knowledgeable in this area.

“Defective” Trusts

The word “defective” usually means that something is wrong. In the area of irrevocable trusts, however, making a trust “defective” can often make the trust much more effective. The use of the word here derives from the fact that, under a “defective” trust, all of the income tax consequences of the trust flow back to the grantor of the trust. Originally, this was considered to be a bad thing, hence the word “defective”, but in many situations, it is actually a good thing and can be used to great advantage.

It needs to be clearly understood that we are talking about a trust that is defective for income tax purposes but definitely not for estate tax purposes. This statement alone connotes the importance of careful drafting and implementation, because one of the primary purposes of an ILIT is to be free of estate taxes, and the last thing anyone wants is to defeat that purpose. Another name for a defective trust is a grantor trust, and these trusts are commonly referred to these days as “intentionally defective grantor trusts”. This is another area of proficiency here at Provada, and we are fully familiar with the best defective provisions to include in a trust.

Here are some examples of what can be accomplished with an intentionally defective grantor trust:

·Inforce policies can be sold to the trust rather than gifted, thereby avoiding the three-year estate
re-inclusion rule. This removes the pressure of having the trust in place before the life insurance sale is completed. Since the grantor and the trust are considered to be one and the same for income tax purposes, the sale is deemed to be to the insured, thereby avoiding the transfer-for-value rule.

·Income producing property can be sold to the trust without income tax consequences, thereby producing income within the trust that can be used to pay premiums. Note that the income is taxed to the trust grantor so that all of the income is available to the trust. Note also that this is not considered to be an additional gift to the trust.

·Other transactions, such as loans, can be entered into between the grantor and the trust without income tax consequences to either.

Conclusion

Crummey and defective trusts have become widely accepted as one of the most effective and versatile tools in the field of estate planning. This brief explanation is intended primarily to whet your appetite and to encourage you to contact us for more information.