The estate and gift tax work hand-in-hand. There is a set limit on the amount you can either give during your life or at your death before the gift/devise will be taxed (lifetime exclusion). The current limit is $12.6 million (which will go back down to $5 million, before inflation, in 2025). This means that if you give over $12.6 million during your life, you will pay gift tax; if you leave an estate worth more than $12.8 million at your death, your estate will be subject to estate tax; and if you both gift and and leave behind assets over $12.6 million, there could be estate or gift tax.
The way the IRS keeps track of gifts, is that they require that any gifts given over a certain amount per year be reported. Your lifetime exclusion will be reduced by the amount reported. Thus, if you give reportable gifts over the lifetime exclusion amount, you will pay gift tax.
The gift tax is not so much a concern as the estate tax. Most people give the majority of their wealth away as an inheritance rather than a gift during their lives. Consequently, the amount given at death, tends to be much larger than the gifts given along the way.
A goal then, would be to attempt to lower your taxable estate without:
1. Chipping away at your lifetime exclusion; and
2. Giving up control over the money you gift.
A strategy to avoid the estate and gift tax is to give an annual gift per year. Currently, the gift tax exclusion is $16k per person, per year. If someone is looking to lower the size of their taxable estate, they can choose to gift an amount up to the annual gift tax exclusion annually.
For example, let’s say George wants to avoid having his estate taxed. He is over the estate tax exemption of $5 million (he doesn’t think he will die until after 2025) and every dollar over that amount is subject to tax. He can lower his net worth by giving away $16,000.00 to each of his children per year for the rest of his life and he would not be required to report the gift.
The problem with gifting in this manner is that the money/asset has been given away. When it comes to money you’ve worked hard to earn, most want to be able to control the assets and also be able to determine when the assets will be distributed.
If George were to gift directly to his children, they could do whatever they want with the money. If they have poor financial habits, an addiction, or a greedy spouse, that money could vanish very quickly. George may want to set that money aside for their college, wedding, retirement etc.
Placing the annual gift into a Crummey Trust will allow George to both make the gifts, which will lower his taxable estate, and control how the money will be distributed to his children. Additionally, if George is married, the trust would allow him and his spouse to double the exemption to $32k per year ($25.2 million for life).
The reason why a transfer to a Crummey Trust qualifies for the annual gift tax exclusion is because the transfer to the trust is treated as a completed gift. You can imagine that a transfer to a regular revocable trust, where the beneficiary has no rights, would not constitute a complete gift. The difference in the Crummey Trust is that the beneficiaries have the right of withdrawal.
The idea is that the beneficiaries will have a right to withdraw contributions made to them in the trust for a period of at least 30 days after having been given notice of the right. However, the expectation is that the beneficiaries will not exercise this right. This tends to be the case, given the leverage the trust maker has over the beneficiary I.e., “if you exercise the right to withdraw, I will just stop making transfers to the trust.”
As long as everyone is on the same page, the Crummey Trust allows for the gift to be made and stay in trust. The money gifted will then be distributed for the express purpose written in the trust document I.e., payment for education. The trust can also control how much the beneficiaries get when the trust maker dies. For example, let’s say that George set aside $500k for his child Chuck. He could mandate, in the trust terms, that Chuck gets his $500k in yearly increments for the next 10 years after George’s death. Thus, George can still control how and why the money he is gifting will go to his beneficiaries.
In conclusion, a Crummey Trust is a great way to lower your taxable estate and take advantage of the annual gift tax exclusion without giving up control over how your assets will pass to the next generation.