Life Insurance Trusts with Crummey Powers and New Case Law
Many clients have or are considering using an irrevocable life insurance trust to minimize estate taxes. Assets properly held in irrevocable trust are not subject to estate tax. Annual gifts can be made to the trust to pay life insurance premiums, subject to beneficiaries’ rights of withdrawal of such assets, known as a “Crummey” withdrawal right.
Most life insurance trusts are drafted to give the beneficiaries the right to withdraw the asset put into the trust. This is intended to ensure the gift qualifies for the annual gift tax exclusion amount as codified in Internal Revenue Code section 2503(b). (The annual exclusion amount is currently $13,000 per person per year.) This withdrawal power is known as a “Crummey” power after the seminal case on the subject Crummey v. Commissioner, 397 F.2d 88 (9th Cir 1968).
Best practice, is to gift the insurance premium amount into the trust and have the trustee give to the beneficiaries a notice or right to withdraw, known as a crummey letter or crummey notice. But, what happens when the premiums are paid straight to the insurance company and no crummey notice or crummey withdrawal power is sent?
In the recent Tax Court case of Estate of Turner v. Comm'r, T.C. Memo. 2011-209 (Aug. 30, 2011), the IRS challenged the availability of the annual exclusion for amounts used to pay policy premiums directly, among other items. The IRS asserted two arguments to prevent the policy premium payments from being treated as annual exclusion gifts:
- First, since premium payments were not made to the trust, the beneficiaries had no meaningful rights to withdraw such amounts and therefore it was not a present interest gift qualifying for the annual exclusion amount.
- Second, since the beneficiaries did not receive notice of the gifts, they did not know of their legal right to demand distributions and the gifts should not qualify as a present interest gift available for the annual gift tax exclusion.
In a monumental victory for the taxpayer, the Tax Court held that both IRS arguments had no impact on the annual exclusion for gift tax purposes. First, it provided that since the trust allowed for withdrawals for direct or indirect distributions, the manner of payment of the premium was not determinative as to whether the gift qualified for the annual exclusion. Secondly, the Tax Court determined the lack of any crummey notice or crummey withdrawal right for the gift did not affect the beneficiary’s legal right to demand a withdrawal.
While it is still advisable clients follow best practices in the funding of life insurance trusts, this case does provide some comfort in circumstances where such advice is not followed (although it should be noted the terms of your trust may change the result). Furthermore, the IRS and other courts have not conceded to this interpretation, so clients not implementing best practices do so at their own peril. If you need any advice on an estate planning or tax issue, please contact Jeffrey Skatoff or Craig Dreyer at (561) 842-4868.
