Chris Moss CPA Tax Attorney
IRS Crummey Gift Tax Audit
by Chris Moss CPA
Welcome to TaxView with Chris Moss CPA Tax Attorney
Do you all own a family business and want to start the process of transferring ownership to your children without getting hit with large gift and estate taxes?
Best practice suggests you consider gifting to your minor children, or if you are the older children, have your parents or grandparents gift to you a Crummey Trust membership through your Family Limited Liability Company. The “Crummey” Trust”, named for Crummey 397 F.2d 82 (9th Cir 1968) is a great way to get tax deductions, have your children receive annual Family LLC memberships, reduce your estate tax and have the family work together in a unified and protected Estate Plan. But danger lies ahead during an IRS Estate tax audit after you die or an IRS Gift tax audit before you die claiming if you died the gifts were not irrevocable, or while you are still living that the Trust should be subject to gift tax by disallowing the tax free exclusions. Either way you lose unless you are structured correctly. So if you are interested in winning for you your family, stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn how to fight back during an IRS Crummey Trust audit so you can win, save taxes, and keep your assets in the family business safe and protected from harm for many generations to come.
Current gift tax law allows exemption for a Husband and Wife to gift tax free $28,000 to a Crummey Trust owning a membership in the Family LLC to each child in 2015. Named after taxpayer Crummey, the Crummey Trust accumulates the $28,000 tax free exemption year after year in a protected irrevocable trust by giving your children the right to demand immediate distribution of exemption. This is exactly what Crummey did in
Crummey vs IRS 397 F.2d 82 (9th Cir 1968).
The facts are simple. Husband and Wife Crummey each gave in 1962 their 4 minor children $3000, the exemption at that time, or $12,000 total to an irrevocable trust. The IRS audited and disallowed the Trust claiming that the gifts to minors were nothing more than disguised future interests disallowed under then IRS Section 2503(b). Crummey appealed first to US Tax Court and next to the US Court of Appeals for the 9th Circuit 397 F.2d 82 (9th Cir 1968).
District Judge Byrne frames the key issued presented as whether or not a present interest was given by the Crummey’s to their minor children so as to qualify for the exclusion under 2503(b). The Court looked to California law to determine if the children had the right to demand distributions from the Trustee. The Government said if the children can’t sue under California law they can’t demand the trust assets under California law. The Crummey’s said if the children can own property under California law they can indeed demand the trust assets under California law.
The Court took particular interest in George W Perkins 27 T.C. 601 (1956) where the Court said that where the parents were capable of asking the Trustee for the assets on behalf of the minor children in order for the children to have the “right to enjoy” the assets and there was no showing that the demand for funds from the children via the parents could be resisted under State law, then the gift was a present interest. The Court in my view did not clearly have an easy answer, but in the end ruled that under Perkins, the “right to enjoy” test is preferable. Crummey win IRS loses.
Where is Crummey trending in 2015? Let’s take you all as an example: In 2015 you and your wife irrevocably gift $28,000 to each of your 3 children ages 5, 7 and 9 and give at this level for 5 more years. If structured through a Crummey Trust your gifts would be $84,000 per year or $420,000 after 5 years all tax free. Further suppose your $28,000 irrevocable gift to each child was an LLC membership interest. With a 35% discount applied to each membership gift for lack of marketability your tax free gifts to 3 children for 5 years would be $630,000.
The Mikel family set up this kind of trust in 2007 with one exception: The Trustee had final and conclusive power to assist the children with “Life Changing Events”, like reasonable wedding costs, the cost to purchase a primary residence, or costs of starting a new trade or business. Finally the Trustee had power over the children’s expenses in connection with their health, education, maintenance and support. The IRS audited Mikel and disallowed the gifts to his children claiming they never were gifted a “present interest in the property” that is an unrestricted right to immediately use the gifts, citing Regulations 2503-3(a) and 2503-3(b) particularly in light of the special “Life Changing Event” powers granted to the trustee. Mikel appealed to the US Tax Court Mikel v IRS, US Tax Court (2015).
Mikel argued and surprisingly IRS conceded that each of the children received a timely and effective notice of their right to withdraw the maximum annual exclusion. Both the Government and Mikel further agreed that the trust declaration stated unequivocally that upon receipt of a timely made withdrawal demand, “the Trustees would have to immediately distribute to the children the property allocable to them.” The IRS finally also conceded that the declaration put forth by Mikel in the Crummey Trust did in fact afford each beneficiary an unconditional right of withdrawal.
However the Government not to be outdone, argued vigorously that the children did not receive a present interest in the trust income and corpus because their rights of withdrawal were not legally enforceable in practical terms. That is the children’s right of withdrawal was “legally enforceable” only if the children could go before New York State Court to enforce their rights and that such an action by the children was not likely to happen considering the special powers for life changing events granted to the Trustee.
Judge Lauber’s thoughtful Opinion acknowledges that the Mikel trust was indeed a Crummey Trust citing Crummey v Commissioner 397 F.2d 82 (9th Cir 1968) with a substantially similar demand clause providing that whenever an addition was made to the trust, the children or their guardian could demand immediate withdrawal of an amount equivalent to the maximum annual exclusion as required by Section 2503(b). The Court further noted that even though the IRS expressed its general agreement with Crummey citing Estate of Cristofani v IRS 97 Tax Court 74 (1991) it appeared to the Court that the Government was challenging Crummey power only when the withdrawal rights are not in substance what they purport to be in form. Judge Lauber nevertheless opined that the Government’s claim that the withdrawal right of Mikel children was illusory was flawed. The Court went on to conclude that the Mikel children under New York law could seek justice to enforce the provisions of the Crummey Trust regardless of the special powers of the Trustee for “Life Changing Events”. The Court therefore found that under New York law withdrawal demands by the beneficiaries could be in fact legally enforced citing Crummey. Mikel wins, IRS loses.
What does this mean for all families with a small business who want to gift Crummey assets to their young children to take advantage of the $28,000 per year gift tax exclusion? First, create your Family LLC with your wife as your partner each donating your share of the family business into the Family LLC. Second, for each subsequent year gift your children Family LLC discounted membership interests to the maximum exclusion $28,000 in 2015 through a Crummey Trust. Third, make sure your Tax Attorney gives the children the absolute right and power under State Law to withdraw their interests. Fourth, by the time your children are in their late teens and early 20s you should have successfully used the Annual Exemption and the Lifetime Exclusion to perhaps have your Family LLC owned by a Spousal Lifetime Access Trust (SLAT) with your wife as Trustee and Beneficiary and your children as successor beneficiaries to further protect your tax free transfer from not only an IRS Estate Tax Audit, but to protect in a spend thrift clause from potential creditors as well. Finally have your tax attorney prepare for you a written opinion that she will file your tax returns and represent you when and if the IRS should audit disallowing your Crummey Trust. Include your Crummey Trust in your tax returns as a contemporaneously prepared PDF file before you file your returns. Rest assured your Estate Plan is safe, secure and protected from IRS audit many years later.
Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney
See you next time on TaxView.
Kindest regards,
Chris Moss CPA Tax Attorney
by Chris Moss CPA
Welcome to TaxView with Chris Moss CPA Tax Attorney
Do you all own a family business and want to start the process of transferring ownership to your children without getting hit with large gift and estate taxes?
Best practice suggests you consider gifting to your minor children, or if you are the older children, have your parents or grandparents gift to you a Crummey Trust membership through your Family Limited Liability Company. The “Crummey” Trust”, named for Crummey 397 F.2d 82 (9th Cir 1968) is a great way to get tax deductions, have your children receive annual Family LLC memberships, reduce your estate tax and have the family work together in a unified and protected Estate Plan. But danger lies ahead during an IRS Estate tax audit after you die or an IRS Gift tax audit before you die claiming if you died the gifts were not irrevocable, or while you are still living that the Trust should be subject to gift tax by disallowing the tax free exclusions. Either way you lose unless you are structured correctly. So if you are interested in winning for you your family, stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn how to fight back during an IRS Crummey Trust audit so you can win, save taxes, and keep your assets in the family business safe and protected from harm for many generations to come.
Current gift tax law allows exemption for a Husband and Wife to gift tax free $28,000 to a Crummey Trust owning a membership in the Family LLC to each child in 2015. Named after taxpayer Crummey, the Crummey Trust accumulates the $28,000 tax free exemption year after year in a protected irrevocable trust by giving your children the right to demand immediate distribution of exemption. This is exactly what Crummey did in
Crummey vs IRS 397 F.2d 82 (9th Cir 1968).
The facts are simple. Husband and Wife Crummey each gave in 1962 their 4 minor children $3000, the exemption at that time, or $12,000 total to an irrevocable trust. The IRS audited and disallowed the Trust claiming that the gifts to minors were nothing more than disguised future interests disallowed under then IRS Section 2503(b). Crummey appealed first to US Tax Court and next to the US Court of Appeals for the 9th Circuit 397 F.2d 82 (9th Cir 1968).
District Judge Byrne frames the key issued presented as whether or not a present interest was given by the Crummey’s to their minor children so as to qualify for the exclusion under 2503(b). The Court looked to California law to determine if the children had the right to demand distributions from the Trustee. The Government said if the children can’t sue under California law they can’t demand the trust assets under California law. The Crummey’s said if the children can own property under California law they can indeed demand the trust assets under California law.
The Court took particular interest in George W Perkins 27 T.C. 601 (1956) where the Court said that where the parents were capable of asking the Trustee for the assets on behalf of the minor children in order for the children to have the “right to enjoy” the assets and there was no showing that the demand for funds from the children via the parents could be resisted under State law, then the gift was a present interest. The Court in my view did not clearly have an easy answer, but in the end ruled that under Perkins, the “right to enjoy” test is preferable. Crummey win IRS loses.
Where is Crummey trending in 2015? Let’s take you all as an example: In 2015 you and your wife irrevocably gift $28,000 to each of your 3 children ages 5, 7 and 9 and give at this level for 5 more years. If structured through a Crummey Trust your gifts would be $84,000 per year or $420,000 after 5 years all tax free. Further suppose your $28,000 irrevocable gift to each child was an LLC membership interest. With a 35% discount applied to each membership gift for lack of marketability your tax free gifts to 3 children for 5 years would be $630,000.
The Mikel family set up this kind of trust in 2007 with one exception: The Trustee had final and conclusive power to assist the children with “Life Changing Events”, like reasonable wedding costs, the cost to purchase a primary residence, or costs of starting a new trade or business. Finally the Trustee had power over the children’s expenses in connection with their health, education, maintenance and support. The IRS audited Mikel and disallowed the gifts to his children claiming they never were gifted a “present interest in the property” that is an unrestricted right to immediately use the gifts, citing Regulations 2503-3(a) and 2503-3(b) particularly in light of the special “Life Changing Event” powers granted to the trustee. Mikel appealed to the US Tax Court Mikel v IRS, US Tax Court (2015).
Mikel argued and surprisingly IRS conceded that each of the children received a timely and effective notice of their right to withdraw the maximum annual exclusion. Both the Government and Mikel further agreed that the trust declaration stated unequivocally that upon receipt of a timely made withdrawal demand, “the Trustees would have to immediately distribute to the children the property allocable to them.” The IRS finally also conceded that the declaration put forth by Mikel in the Crummey Trust did in fact afford each beneficiary an unconditional right of withdrawal.
However the Government not to be outdone, argued vigorously that the children did not receive a present interest in the trust income and corpus because their rights of withdrawal were not legally enforceable in practical terms. That is the children’s right of withdrawal was “legally enforceable” only if the children could go before New York State Court to enforce their rights and that such an action by the children was not likely to happen considering the special powers for life changing events granted to the Trustee.
Judge Lauber’s thoughtful Opinion acknowledges that the Mikel trust was indeed a Crummey Trust citing Crummey v Commissioner 397 F.2d 82 (9th Cir 1968) with a substantially similar demand clause providing that whenever an addition was made to the trust, the children or their guardian could demand immediate withdrawal of an amount equivalent to the maximum annual exclusion as required by Section 2503(b). The Court further noted that even though the IRS expressed its general agreement with Crummey citing Estate of Cristofani v IRS 97 Tax Court 74 (1991) it appeared to the Court that the Government was challenging Crummey power only when the withdrawal rights are not in substance what they purport to be in form. Judge Lauber nevertheless opined that the Government’s claim that the withdrawal right of Mikel children was illusory was flawed. The Court went on to conclude that the Mikel children under New York law could seek justice to enforce the provisions of the Crummey Trust regardless of the special powers of the Trustee for “Life Changing Events”. The Court therefore found that under New York law withdrawal demands by the beneficiaries could be in fact legally enforced citing Crummey. Mikel wins, IRS loses.
What does this mean for all families with a small business who want to gift Crummey assets to their young children to take advantage of the $28,000 per year gift tax exclusion? First, create your Family LLC with your wife as your partner each donating your share of the family business into the Family LLC. Second, for each subsequent year gift your children Family LLC discounted membership interests to the maximum exclusion $28,000 in 2015 through a Crummey Trust. Third, make sure your Tax Attorney gives the children the absolute right and power under State Law to withdraw their interests. Fourth, by the time your children are in their late teens and early 20s you should have successfully used the Annual Exemption and the Lifetime Exclusion to perhaps have your Family LLC owned by a Spousal Lifetime Access Trust (SLAT) with your wife as Trustee and Beneficiary and your children as successor beneficiaries to further protect your tax free transfer from not only an IRS Estate Tax Audit, but to protect in a spend thrift clause from potential creditors as well. Finally have your tax attorney prepare for you a written opinion that she will file your tax returns and represent you when and if the IRS should audit disallowing your Crummey Trust. Include your Crummey Trust in your tax returns as a contemporaneously prepared PDF file before you file your returns. Rest assured your Estate Plan is safe, secure and protected from IRS audit many years later.
Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney
See you next time on TaxView.
Kindest regards,
Chris Moss CPA Tax Attorney
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