The Present Interest Annual Exclusion – It’s More than Just Giving Up Rights in the Gifted Property (i.e., Gifting Entity Interests May Get Crummey)
The present interest annual exclusion is a key component of the federal gift tax. The exclusion is presently $13,000 per donee per year. That means that a donor can make gifts of up to $13,000 per year per donee (in cash or an equivalent amount of property) without triggering any gift tax, and without any need to file Form 709 – the federal gift tax return. Because the exclusion “renews” each year and is not limited by the number of potential donees, but only the amount of the donor’s funds and interest in making gifts, the exclusion can be a key estate planning tool. Used wisely, the exclusion can facilitate the passage of significant value to others (typically family members) pre-death to aid in the succession of a family business or a reduction in the potential size of the donor’s taxable estate (assuming the federal estate tax is restored in the future), or both. But, to qualify for the exclusion, the gift must be a gift of a present interest – the exclusion does not apply to future interests.
Whether gifts are present interests that qualify for the annual exclusion has been a particular issue in the context of trust gifts that benefit minors. In 1945, the U.S. Supreme Court decided two such cases. In Fondren v. Comr. and Comr. v. Disston, the donor created a trust that benefitted a minor. In Fondren, the trustee had the discretion to distribute principal and income for the minors support, maintenance and education and, in Disston, the trustee had to apply to the minor’s benefit such income “as may be necessary for…education, comfort, and support.” In both cases, the Court determined that the minor was not entitled to any amount of a “specific and identifiable income stream.” So, no present interest was involved. But, what if the minor (or any other transferor, for that matter) had a right to demand the trust property via a right to withdraw the gifted property from the trust? Is that the same as outright ownership such that the gifted property would qualify the donor for an annual exclusion on a per donee basis? In 1951, the U.S. Court of Appeals for the Seventh Circuit said “yes” in a case involving an unlimited timeframe in which the withdrawal right could be exercised, but in 1952 the U.S. Court of Appeals for the Second Circuit said “no” because it wasn’t probable that the minor would need the funds. However, in 1968, the U.S. Circuit Court of Appeals in Crummey v. Comr., allowed present interest annual exclusions for gifts to a trust for minors that were subject to the minor’s right to demand withdrawal for a limited timeframe without any need to determine how likely it was that a particular minor beneficiary would actually need the gifted property. Since the time of the Ninth Circuit’s decision, the “Crummey demand power” technique has become widely used to assure availability of annual exclusions while minimizing the donees’ access to the gifted property.
Crummey-type demand powers may suddenly become more relevant in the context of gifted interests in closely-held entities. In 2003, the U.S. Court of Appeals for the Seventh Circuit, affirming the Tax Court, ruled that because there were substantial restrictions on transferred interests in a limited liability company (LLC) the donee did not have a present beneficial interest in the gifted property. Thus, the gifts of the LLC interests were taxable. Now, the Tax Court has applied the same principle to transfers of limited partnership interests, and a federal district court has again ruled similarly with respect to LLC interests. The Tax Court, however, did provide a list of the types of restrictions that made the gifts future interests. That could prove helpful for future planning in similar situations.
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