Crummey Powers and 5 and 5 powers are two of the most common forms of withdrawal rights granted to beneficiaries of trusts.  Planners using trusts containing such withdrawal rights must be aware that many states have passed versions of the Uniform Trust Code (the “UTC”).  Section 505(b) of the UTC, a provision related to self-settled trusts, contains a rule applicable to trust agreements that include Crummey Powers and 5 and 5 powers.  This rule provides in relevant part:

(1) during the period the power may be exercised, the holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust to the extent of the property subject to the power; and (2) upon the lapse, release, or waiver of the power, the holder is treated as the settlor of the trust only to the extent the value of the property affected by the lapse, release, or waiver exceeds the greater of the amount specified in Section 2041(b)(2) or 2514(e) of the Internal Revenue Code of 1986, or Section 2503(b) of the Internal Revenue Code of 1986, in each case as in effect on [the effective date of this [Code]] [, or as later amended].

Review of Crummey Powers:  All gratuitous lifetime transfers of property by individuals are potentially subject to the gift tax under § 2501(a).²   Nonetheless, the first $12,000 of gifts made to any individual during each year need not be treated as taxable gifts for such year.³   An “annual exclusion gift” is a gift of a “present interest” in property, i.e., an interest in property which is an unrestricted right to the immediate use, possession, or enjoyment of the property gifted.⁴

When there is a gift in trust, all or a portion of the transfer may be a future interest in property.⁵   Under Regulation § 25.2503-3(a), no portion of the value of a gift of a future interest may be excluded in determining the amount of gifts made during the calendar period.  The term “future interest” is a legal term that includes reversions, remainders, and other interests or estates that are limited to commence in use, possession, or enjoyment at some future date or time.⁶

A gift in trust can be converted to a present interest qualifying for the annual exclusion under § 2503(b) by granting one or more beneficiaries a limited demand power or withdrawal right (that is, a “Crummey Power”) over a contribution of property to a trust.⁷   A Crummey Power is a withdrawal right granted to a beneficiary as a result of a gift (or a deemed gift) to a trust.  It permits a beneficiary to demand that the trustee distribute the gift (or other assets of equivalent value in the trust) to the beneficiary. Typically, the Crummey Power may be exercised for a limited period such as thirty days or until the end of the year in which the contribution is made to the trust.  Upon the expiration of the withdrawal period, the property (or value) that was subject to the withdrawal power continues to be administered and disposed of as provided in the trust.

Review of 5 and 5 Powers:  A 5 and 5 power typically grants a beneficiary the right to withdraw property from a trust for an entire year or on a less frequent basis, for example, for one month or one day of the year.  A 5 and 5 power usually grants a beneficiary the right to withdraw an amount equal to the greater of $5,000 or 5% of the trust corpus valued on an annual basis.  The 5 and 5 power is granted to a beneficiary based on the amounts set forth in §§ 2041(b) (2) and 2514(e).  It is often used to give a beneficiary greater access to trust corpus during a year without interference by a trustee and without causing adverse gift or estate tax consequences should the beneficiary elect not to exercise all or any portion of such withdrawal power.⁸

Section 505(b) of the UTC:  In interpreting Section 505(b) of the UTC, it is important to refer to Section 103(11) of the UTC which defines the term “power of withdrawal.”  It provides that the term means a general power of appointment that is presently exercisable by the donee of the power except a power that:

(1) can be exercised by a trustee and is limited by an ascertainable standard; or
(2) may be exercised by another person only with the consent of:
            (a) the trustee; or
            (b) a person holding an adverse interest.

Hanging Powers.  When a trust contains “Hanging Power Provisions” annual exclusion gifts may be made to the trust subject to Crummey Power rights granted to one or more beneficiaries.  After a limited period, the portion of any transfer (or transfers) subject to a Crummey Power which may lapse within the 5 and 5 exemption under §§ 2041(b)(2) and 2514(e) is directed to lapse.⁹   The remainder of such transfer (or transfers) continues to be subject to the beneficiaries’ Crummey Power rights.  The trust is designed so that the “hanging” amount will lapse (in whole or in part) within the 5 and 5 exemption for each successive tax year.  In trusts that contain Hanging Power Provisions it may be critical to ascertain the portion of a withdrawal power that is permitted to lapse or has previously lapsed at a particular time to resolve a controversy involving a creditor’s rights to trust assets.

A crucial question is whether §§ 2041(b)(2) and 2514(e) of the Code (which are specifically referenced in Section 505(b) of the UTC) provide a sufficient basis for a court or litigants to determine the portion of a trust that is subject to the continuing withdrawal rights of an individual possessing a withdrawal power.  Surprisingly, the answer to this question may be determined by reference to Revenue Rulings, Private Letter Rulings, Technical Advice Memoranda, Chief Counsel Advice, and Field Service Advice published by the Internal Revenue Service (hereinafter referred to as the “Service”).  An important question is whether this is appropriate authority for a state court to rely upon to make such a determination.  In other words, is it sensible to permit federal tax law and the interpretation of the Code by the Service through its published documents to have such a significant effect on State creditor’s rights law.

Section 2514(e) of the Code provides that the lapse of a general power of appointment during the life of an individual possessing the power is considered a release of the power.  This rule, however, is only applicable with respect to the lapse of powers during any calendar year to the extent the value of property that could have been appointed exceeds the greater of (a) $5,000 or (b) 5% of the aggregate value of the assets out of which, or the proceeds of which, the exercise of the lapsed powers could be satisfied.¹⁰ The 5 and 5 exemption applies on an annual basis.  According to the Service, each donee is granted one 5 and 5 exemption each calendar year, regardless of the number of trusts in which a donee is granted a Crummey Power or the number of annual exclusion gifts made to a trust.¹¹

A donee may possess multiple Crummey Powers if such donee is a beneficiary of more than one trust.  Additionally, successive contributions to a single trust may be made in the same calendar year.  Thus, multiple or successive lapses may occur in a single year.  Furthermore, multiple and successive lapses may occur under a trust or trusts created by the same or different grantors or to which different donors make gifts.

In Revenue Ruling 85-88, 1985-2 CB 201, the Service addressed the tax consequences of multiple and successive lapsing Crummey Powers in a single calendar year.  The ruling provided two fact situations.  In Situation 1, G established an irrevocable trust in March of 1982 under which S was given all of the income for life and the remainder was given to C.  S was also given a Crummey Power “to withdraw up to $5,000 from each contribution made by any donor to the trust.”  S had the right to exercise the Crummey Power for sixty days following notice of the transfer to the trust.  G transferred $5,000 to the trust on the date it was established, and S did not exercise the Crummey Power.  In September of 1982, G transferred an additional $5,000 to the trust, and S also permitted that Crummey Power to lapse.  In Situation 2, G established two irrevocable trusts in February 1982 with the same terms as the trust in Situation 1.  G transferred $5,000 to each trust at the time the trusts were established.  S was notified of each transfer but failed to exercise either Crummey Power.  The ruling held that S was entitled to only one 5 and 5 exemption in 1982 and providing multiple 5 and 5 exemptions “would undermine the statutory purpose to limit the exemption provided by section 2514(e).”

Thus, in both situations, S was treated as the transferor of $5,000 of property to the trusts in 1982.  The ruling noted that there is no indication Congress intended the holder of multiple noncumulative general powers should be granted more than one 5 and 5 exemption for any calendar year.  The ruling also noted that the statute uses the term “powers” in the plural.  In determining what the “aggregate value of the assets out of which” the exercise of the lapsed powers could be satisfied, the ruling explained that:

[T]he 5 percent test . . . is stated in terms of ‘the aggregate value of the assets out of which . . . the exercise of the lapsed powers could be satisfied.’. . . The 5 percent test is based on the value of the assets subject to the power at the time of the lapse of the power. [Citation omitted]. Where the donee has more than one noncumulative withdrawal power in the same trust that lapses in a calendar year, the 5 percent test is based on the maximum amount subject to the donee’s withdrawal power on the date of lapse of any such power during the calendar year.  Where the donee has noncumulative powers to withdraw property from two or more trusts, the 5 percent test is applied by aggregating the amount determined pursuant to the preceding sentence for each such trust with respect to which the withdrawal power has lapsed during the calendar year. (Emphasis added.)