Do I Really Have to Send These Crummey Notices? It Depends on the “Totality of Circumstances”

My last blog, The Crummey Side of Trust Banking, examined the basics of the Irrevocable Life Insurance Trust. One of the administrative steps included was sending notice to the beneficiaries with a right to demand a disbursement after a gift. There are a myriad of consequences when a beneficiary decides to make a demand and that naturally leads to the question, “do you really have to send them a notice?”

As a refresher, Crummey v. Commissioner of Internal Revenue, 397 F.2d 82 (9th Cir. 1968), held that a demand provision in an irrevocable trust gave the beneficiaries a “present interest” in the gift to a trust sufficient to qualify the gift for the annual gift tax exclusion in Section 2503(b) of the Internal Revenue Code, even if the beneficiaries of the interest were minors. However, the Tax Court ruled in 1983 that a power to demand the gift is not eligible for the exclusion if the settlor’s conduct makes the demand “illusory.” See Rev. Rul. 81-7.

Crummey did not directly address the issue of whether the beneficiaries of the trust needed to be notified of their right to demand trust corpus the question lingered, but some rules eventually emerged. Estate of Cristofani v. Commissioner of Internal Revenue, 97 T.C. No. 5 (1991) held that demand beneficiaries were not required to be ultimate beneficiaries of the trust (although the IRS pledged to continue to litigate cases with facts indicating the purpose of the gift was merely to satisfy gift tax provisions).

The United States Tax Court went a step further in Estate of Turner v. Commissioner of Internal Revenue, T.C. Memo. 2011-209 (2011) (As supplemented by 138 T.C. No. 14 (2012)), stating the fact that some of the beneficiaries may not have known they had a demand right does not affect their legal right to the demand, thus making it a present interest. It’s important to note in all of these cases the courts found that there was (1) no agreement between the settlor and beneficiaries not to demand the gift and (2) the trustee, upon receiving a demand, lacked the legal power to resist payment.

So, why are we still sending notices? The answer is in the test used to evaluate whether the demand power is “illusory.” The IRS uses a “totality of circumstances” test to determine whether the demand provisions should be treated as a “present interest” for gift tax purposes. Sending notices builds an evidentiary record for the estate [and the trust/trustee] to help defend against any dispute with the IRS when it comes time to pay estate taxes with the life insurance proceeds. Without evidence a disputed trust could be pulled back into the estate for tax purposes opening the trustee bank to liability for a possible fiduciary breach.

Every trust and trust type presents unique challenges and risks for bank trust officers. When confronted with an unfamiliar challenge bank trust departments should seek guidance from a trusted attorney to reduce the risk of exposure to lawsuits based on breached fiduciary duties.