Mikel: The Tax Court’s Latest Word on Crummey PowersMay 6, 2015 Estate Planning Blog
The Tax Court recently issued a memorandum decision in the case of Israel and Erna Mikel providing guidance on the efficacy of Crummey withdrawal rights in a unique fact pattern.
In 2007, Israel and Erna Mikel each made gifts valued at approximately $1.6 million to a family trust. On a late filed gift tax return, each of them claimed an annual exclusion of $720,000 – i.e., $12,000 for each of the 60 (that's right, 60!) beneficiaries of the trust, many of whom were minors. The trust contained typical Crummey withdrawal powers limited to the annual exclusion. The trustees were required to give the beneficiaries notice of this right and were obligated to honor any request for funds. The trustee mailed these notices to the beneficiaries four months after the gifts were made.
The trust also permitted the trustees to make discretionary distributions for the health, education, maintenance and support of any beneficiary. These distributions could also be made in the trustees' absolute and unreviewable discretion to assist with a wedding, purchasing a primary residence or entering a trade or profession. The trustees' judgment as to the amounts of such payments and their advisability was to be final and conclusive. Any dispute about the trust was to be submitted to arbitration before a panel of three persons of the Orthodox Jewish faith, which was directed to enforce the trust and give the challenging party the rights he was entitled to under New York law. The trust also included an "in terrorem" provision to discourage beneficiaries from challenging discretionary acts of the trustees.
The service challenged the annual exclusions from gift tax, asserting that the beneficiaries did not receive the required "present interest" in the gifted property because the withdrawal rights were not legally enforceable in practical terms. According to the service, a withdrawal right is legally enforceable only if a state court will enforce the right. The service argued that a beneficiary of this trust would be reluctant to do that because of the in terrorem provision. The Tax Court found that the in terrorem provision governed only the discretionary decisions of the trustees, not the requirement of making distributions upon demand as required by the Crummey withdrawal rights. As a result, the Tax Court allowed the annual exclusions.
Beyond the court's holding on the annual exclusion issue, I find two ancillary aspects of the Mikel case noteworthy. The first is that the Mikels never filed gift tax returns in connection with the 2007 gifts, which were valued at over $3.2 million. The Tax Court's opinion states that the gifts consisted of a residence in Brooklyn, two other properties in Brooklyn (owned by LLCs) and a Florida condo. The Tax Court also mentions that the Mikels filed returns "after being contacted by the IRS." The Tax Court does not specifically mention how the service learned of the transfers, but in all likelihood the transactions were uncovered as part of the service's practice of searching real estate records in an effort to find unreported gifts. When it comes to gifts of real estate, filing a gift tax return is always the best practice, regardless of the value of the gift or whether it is covered by annual exclusions. Chances are, if you don't file, the service will find out about it and, when filed, the return is certain to be scrutinized.
The second interesting part about the case is that the Tax Court allowed annual exclusions for 60 beneficiaries of the trust. The trust document was not available on the Tax Court's website, so we don't know what rights the beneficiaries had in the trust other than the Crummey withdrawal rights and a right to distributions of trust property based on an ascertainable standard, exercisable in the trustees' "sole and absolute discretion." The service didn't argue that the inclusion of 60 Crummey power holders was a scheme aimed at maximizing the nontaxable portion of the gift. So, it seems fair to assume that the service thought that each of these 60 beneficiaries held a legitimate substantial interest in the trust beyond the Crummey withdrawal right. For advisers handling cases where it's important to preserve, or minimize the use of, a client's lifetime gifting exclusion, the terms of the Mikels' trust could prove instructive.