Crummey Letters: Turning a Gift to a Trust Into a Present Interest

Why a gift to a trust doesn’t qualify

The federal annual gift-tax exclusion lets you give a set amount to any number of people each year with no gift tax and no use of your lifetime exemption. But there is a catch written into the statute: the exclusion applies only to gifts of a present interest, not to “gifts … of future interests in property” (IRC § 2503(b)). A present interest is one the recipient can use and enjoy right now. A future interest is one they have to wait for.

A gift to an ILIT is, on its face, a future interest. The money goes into a trust the beneficiaries cannot touch — it exists to pay insurance premiums and to pay out at your death. Nothing about it is enjoyable “right now.” So without more, every premium gift to the trust would fail the present-interest test, use up your lifetime exemption, and eventually require gift tax. That would make funding an ILIT with modest annual gifts unworkable.

The Crummey fix

The solution comes from a 1968 case. In Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), a trust gave its beneficiaries the right to withdraw each contribution for a limited window after it was made. The Ninth Circuit held that this withdrawal right made each contribution a gift of a present interest — one the beneficiary could demand immediately — even though, in practice, the beneficiaries were not expected to exercise it. The legal ability to withdraw is what matters, not the likelihood that anyone will.

The Tax Court later extended the logic even to beneficiaries who held only a withdrawal right plus a contingent future interest, treating their power to withdraw as a present interest (Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991)). That case is why some trusts grant withdrawal rights to a wider circle of beneficiaries — and why the IRS pushed back, as below.

Notice hygiene

For the withdrawal right to be real, the beneficiary has to know about it and have a genuine chance to use it. A right nobody is told about, that lapses before it can be exercised, is illusory — and an illusory right does not create a present interest, so the exclusion is lost (Rev. Rul. 81-7, 1981-1 C.B. 474, holding that a withdrawal power the beneficiary had no real opportunity to exercise produced only a future-interest gift). That ruling is the origin of the practice known as the “Crummey letter.”

Nothing in the statute or regulations prescribes a particular form or a particular number of days — the notice is a practitioner convention built on the case law, not a filing. What the convention asks for is straightforward:

• Actual written notice to each beneficiary (or a guardian for a minor) each time a contribution is made.
• A real window to exercise the right — commonly around 30 days — before it lapses.
• A paper trail: keeping copies of the notices with the trust records, so the present-interest treatment can be proven if the return is examined.

The discipline is annual and unglamorous, and skipping it is one of the most common ways a well-drafted ILIT quietly loses its tax footing. It is part of the recurring administration burden the costs page warns about.

The lapse problem: 5-and-5

There is a subtle tax trap on the beneficiary’s side. A Crummey withdrawal right is a general power of appointment. When the beneficiary lets it lapse, the tax code can treat that lapse as the beneficiary having made a gift — to the other trust beneficiaries — of the amount they chose not to withdraw. The code forgives this, but only up to a limit: a lapse is treated as a taxable release only to the extent the lapsed amount exceeds the greater of $5,000 or 5% of the trust’s assets (IRC § 2514(e)). This is the famous “5-and-5” limit.

When annual contributions exceed the 5-and-5 amount per beneficiary, drafters manage the overage — often with a “hanging power” that lets the unused withdrawal right lapse gradually over several years, staying within the 5-and-5 limit each year. This is a drafting detail, but it is the reason ILIT documents are more intricate than they first appear, and a reason to have one drawn by a specialist.

The IRS’s audit posture

The IRS has never loved Crummey powers, and it has drawn a line it will litigate. After the Tax Court’s taxpayer-friendly ruling in Cristofani, the IRS acquiesced in the result only — accepting the outcome on those facts while rejecting a broad reading of the case (Action on Decision 1992-09). It then signaled, and has since pursued, a narrower attack: where a beneficiary holds a withdrawal right but no other real economic interest in the trust — a “naked” power — and the facts suggest a prearranged understanding that the right will never be exercised, the IRS will deny the exclusion (Technical Advice Memorandum 9628004; Action on Decision 1996-10). The agency’s Actions on Decisions record its litigating positions.

What a notice contains

Because people ask, here is what a Crummey notice typically communicates. This is an educational description of the elements, not a legal form — do not copy it as a template. A trustee should use notices drafted for the specific trust by the attorney who wrote it.

Sources & methodology