The Voice is the e-mail newsletter of The Special Needs Alliance. This installment was written by H. Amos Goodall, Jr., CELA of the State College, Pennsylvania law firm Goodall & Yurchak, P.C. His practice emphasizes estate planning and implementation for elders, persons with special needs and their families. A member of the Special Needs Alliance and of the National Academy of Elder Law Attorneys, Amos is also a Fellow of the American College of Trust and Estate Counsel
How can families transfer and hold funds to be used to help a child with special needs while avoiding gift taxes or a reduction in their protection from estate taxes? How can parents provide a way for other family members to do so as well?
Parents should consider creating “standalone” special needs trusts for their children with disabilities. This is an excellent idea for many reasons, including supplying an account for other relatives to contribute to for the child’s benefit. Without this, a well-meaning relative may simply name the child with disabilities as a beneficiary on a life insurance policy or in a will — either jeopardizing the child’s benefits or requiring the creation of a much more restrictive kind of trust. Also, grandparents often want to provide for all their grandchildren, and while a Section 529 education account may be appropriate for a child going to college, a special needs trust may be more appropriate for a child with disabilities
Gift and estate tax laws can complicate matters for wealthy persons when funding a standalone trust. A contribution to a trust is a gift subject to gift tax, like most other gifts. Most families are aware of the annual exclusion from federal gift tax, which permits gifts of up to $13,000 (adjusted annually for inflation) per year from each person making a gift to each recipient, without the gift counting against the $1 million limit on gifts that can be made without payment of federal gift tax. Since married partners can allocate their annual exclusion to their partners, grandparents can give $26,000 to each grandchild in a particular year without any gift tax consequences. Gifts that exceed the annual exclusion will either be subject to a gift tax or will reduce the donor’s protection from state and federal estate taxes.
Unfortunately, this annual exclusion does not normally apply to gifts to a trust. This is because the annual exclusion is available only if the recipient has a “present interest” in the gifted property — the immediate right to use the property. Gifts in trust usually limit the use of the property to a trustee’s discretion or to distribution at a later time.
A number of years ago, attorneys devised a method of making gifts to trusts qualify for the annual exclusion by including a special withdrawal power in the trust, and this technique was recognized in a case called Crummey v. Commissioner. As a result, trusts incorporating this withdrawal power are known as “Crummey trusts” and the withdrawal powers are called “Crummey powers.” These Crummey powers are often found in trusts that own life insurance, sometimes called “life insurance trusts.”
How do Crummey trusts work? The donor (such as a parent) creates a trust which contains a provision that allows the donee or beneficiary to withdraw funds deposited into the trust for a period of time, typically 30 days from the date of notice to the beneficiary. At the end of the 30 day notice period, if the beneficiary has not withdrawn the funds, the beneficiary loses the right to do so. The IRS generally classifies gifts to Crummey trusts as present interest transfers, therefore eligible for the annual exclusion. It may not be surprising to learn that Crummey beneficiaries very rarely exercise their power to withdraw the donated funds!
This technique by itself is not necessarily useful to parents of children with disabilities, since most agencies hold that a “withdrawable” transfer is an available resource. In the year of gift, the amount will be “available”; afterwards, the child may be considered to have made a gift by not exercising the withdrawal power. Thus, the Crummey case alone may not solve the problem.
Fortunately, attorneys have devised a second technique that can be useful for beneficiaries with special needs — a trust which gives the right of withdrawal to someone other than the beneficiary with disabilities (even though the person with disabilities is the person the trust is really designed to benefit). This technique was approved by the Tax Court in a case known as Estate of Maria Cristofani.
In Cristofani the donor created an irrevocable trust naming her children as primary trust beneficiaries and minor grandchildren as contingent beneficiaries. In an effort to multiply the allowable gift tax exclusions, the trust gave both the children and the grandchildren Crummey withdrawal rights. If children and grandchildren did not withdraw the funds, the funds remained in the trust for the benefit of the children, only going to the grandchildren if their parents did not survive the donor for 120 days. The grandchildren’s possibility of getting the trust property if their parents didn’t survive is called a “contingent remainder.” The IRS took the position that the annual exclusion did not apply to the gifts which the grandchildren had the right to withdraw, because all the grandchildren had was a “contingent remainder,” but the Tax Court disagreed. The Tax Court held that the grandchildren’s withdrawal rights made the gifts qualify for the annual exclusion, even though the trust really benefited their parents.
Thus, the court’s decision in Cristofani suggests that a trust could include a Crummey withdrawal right for a person other than the beneficiary with a disability, which would cause the gift to qualify for the annual exclusion without the gift being an available resource to the disabled donee.
This planning strategy has some limits. The IRS believes that trusts like the one in the Cristofani case give rise to a suspicion that there is collusion between the parties, a secret agreement that the withdrawal right will not be exercised. The IRS has indicated that it will consider challenging arrangements where the withdrawal power resides in someone other than a current beneficiary. In one opinion, the IRS said: “the Service will deny exclusions for powers by individuals who either have no property in the trust except for Crummey powers or hold only contingent remainder interests.” Even though one more Tax Court case like Cristofani has been decided in favor of a beneficiary, it would still be very aggressive planning to rely on that case and Cristofani when the IRS has said it will continue to challenge such trusts.
Therefore, if avoiding the gift or estate taxes is important, the Crummey withdrawal power should be limited to someone who will be receiving at least some of the assets in the trust after the child with disabilities passes on, and even then, the family will need to be prepared to prove to the IRS that there are circumstances indicating that there was no collusion between the donor and the holder of the Crummey withdrawal power. A carefully planned trust with named remainder beneficiaries can theoretically give withdrawal powers to these beneficiaries, so that grandparents and others could make annual exclusion gifts into this trust=96assuming that they will ultimately be used for the benefit of the child with disabilities, without being deemed an available resource and without interfering with a child’s present benefits. Alternatively, the trust could give a set amount — preferably more than 5% — to other children, and those children would have the Crummey withdrawal powers.
This is a specialized planning technique, and it should only be attempted with the advice of an attorney who is well versed in both special needs and tax law. However, it can allow parents and others to benefit a child with special needs while reducing tax consequences.
Most people will not have to worry about federal gift or estate taxes, so the complexities of a trust with Crummey powers can be avoided. However, if these taxes are a part of your planning, a properly constructed trust with Crummey powers can be advantageous. A knowledgeable special needs attorney can help you make this decision.