The annual federal gift tax exclusion allows an individual to gift up to $14,000 (or $28,000 if spouses elect to split gifts) in 2016 to as many people as he or she wishes, free of gift taxes and without those gifts counting against the donor’s $5.45 million lifetime gift tax exemption. This is a powerful technique. For example, if a donor and her spouse were to transfer $28,000 to a child on the day he was born and on every subsequent birthday until the child reached age 18, then at age 18 the child would have received about $504,000, plus income and appreciation. For the wealthy, annual gifting is highly recommended, as it can effectively reduce the donor's taxable estate by removing the value of the gifts, as well as all the future appreciation associated with those gifts. Depending upon the size of their families, parents and grandparents can make annual gifts to their children and grandchildren that may easily exceed $100,000 per year, without incurring a gift tax or reducing their lifetime gift tax exemption amount.
When making these annual gifts, the donor must decide whether or not to make an outright gift. However, when gifting to a minor, an outright gift of any substantial size is almost never advisable. Accordingly, the donor should consider alternative methods that offer continued control in order to preserve the gift and allow it to appreciate for the benefit of the minor. The Crummey trust and the 2503(c) trust are two of the most commonly utilized methods for making annual exclusion gifts to minors.
A Crummey trust allows a parent, grandparent or other donor to make tax-free gifts to a child’s (or children's) trust and use their annual federal gift tax exclusion. A Crummey trust may allow the Trustee to make discretionary distributions or, instead, may limit distributions to an ascertainable standard, such as the beneficiary’s education, health, maintenance or support. Investments can be in whatever the trust document provides. A Crummey trust may be drafted and structured so that gifts to it will be exempt from the generation-skipping transfer (GST) tax (which typically applies to gifts from a grandparent to grandchildren) without the use of the donor's exemption from GST tax.
Immediately following a gift to such a trust, notice of the gift must be given to the beneficiary (or the non-donor parent of a minor beneficiary) and the beneficiary is given a period of time during which the gift may be withdrawn from the trust (typically, 30 or 60 days). When the withdrawal period ends, the gifted amount irrevocably becomes the property of the trust. The withdrawal right creates a present interest in the gifted amount so that the gift qualifies for the annual gift tax exclusion.
Unlike the 2503(c) trust, there is no mandatory distribution of trust principal at age 21. An additional advantage over the 2503(c) trust is that the Crummey trust can be drafted to allow a parent to serve as Trustee, without causing adverse estate tax consequences. However, the administrative burdens of documenting gifts and creating withdrawal notices can sometimes serve as a deterrent to establishing this type of trust.
A 2503(c) trust, or minor's trust, is a trust established to hold gifts for one child until he or she attains age 21. A gift to this type of trust qualifies for the annual federal gift tax exclusion. Principal and income in the trust can be distributed to the child or used for the child’s benefit, in the discretion of the Trustee. Unused or undistributed principal and income can be accumulated in the trust until the child reaches age 21. The trust can be authorized to invest in virtually any prudent investment. In addition, gifts to a 2503(c) trust will always be exempt from generation-skipping transfer (GST) tax.
There is no need for “Crummey” withdrawal notices (as required for insurance trusts and Crummey trusts) and, to the extent the trust is maintained for college costs only, virtually all of the trust assets may be gone by the time the beneficiary attains age 21. Upon the child reaching age 21, the trust must terminate and the remaining assets must be distributed outright to the beneficiary. However, if the trust is intended to hold more than college funds and the Trustee would like the assets to remain in trust following the child’s 21st birthday, the beneficiary may be given a short period of time after reaching age 21 (typically, 30 or 60 days), during which he or she has the unrestricted right to withdraw the remaining trust funds. If the funds are not withdrawn, the assets can be continued in trust.
If the beneficiary dies before attaining age 21 (when the trust terminates), then the trustee must pay the trust assets to the minor's estate or as the minor appoints pursuant to a general power of appointment.
In order to avoid adverse estate tax consequences, neither the parent of the beneficiary nor the donor should serve as the trustee of a 2503(c) trust. The minor's parent, however, could serve as co-trustee without adverse transfer tax consequences, provided that the trust instrument gives the non-parent trustee the power to make distributions that might satisfy the parent's legal obligation of support.
Please contact Lara M. Sass, PLLC to discuss the pros and cons of each vehicle discussed herein. The use of either of these effective methods will allow you to make very substantial gifts free of federal gift tax and to remove the amount of these gifts (plus any future appreciation) from your taxable estate.