Foraging through our living room cabinets the other day, my three daughters found my old high school yearbooks. They laughed over some of the inane notes scribbled by classmates within the pages, and had even more fun seeing their old man as a teenager in his 1970s style haircuts. They especially guffawed at my high school swim team picture, as you might imagine for obvious reasons.
Keeping these old mementos has a way of linking one generation to the next. It anchors us in our history and shows our children that we were also once adolescents trying to figure out who we were and where we were going.
Retaining old letters has a more significant financial impact on your family when we talk about irrevocable life insurance trusts (ILITs). You may have established an irrevocable life insurance trust many years ago on the advice of your estate planning attorney. At that time, he likely counseled that by transferring the life insurance policies into the ILIT, you could eliminate or reduce the value of the death benefit from your estate for federal estate tax purposes.
You may also remember your estate planning attorney telling you something about the policy premium payments. In order to qualify the premium payments as “gift tax free” a certain procedure has to be followed. First, the trustee of the ILIT should establish a checking account in the name of the trustee for the ILIT. Second, you should deposit amounts into the ILIT checking account at least thirty days prior to the date that the annual premium payment is required to be paid to keep the life insurance policy current. Third, the trustee then should send out “Crummey notices” to the beneficiaries of the ILIT, advising them of the contribution to the ILIT and advising them that they have a certain time period prescribed under the terms of the ILIT in which to withdraw the funds attributed to their share.
Some of you might now be confused, “Huh? What’s a Crummey letter?” A “Crummey letter” or “Crummey notice” is named after a 1969 Tax Court Case Crummey vs. Commissioner. In that case the taxpayer argued that so long as an irrevocable trust does not pay out until some future event (the death of its grantor, for example), the gift (contribution of premium payments) to the trust should qualify as “gift tax free” so long as each beneficiary is afforded a demand right. So long as the demand right allows the beneficiary the right to withdraw his share of the contribution to the trust presently then the gift should be considered a “present interest gift.”
The Tax Court agreed with the taxpayers. Since that time, estate planning attorneys have established ILITs that contain the Crummey notice language, resulting in removing the life insurance contract from the client’s estate while at the same time qualifying the premium contributions as “present interest gifts”.
Qualifying a gift as a “present interest” gift is important, as for a gift to count towards the annual exclusion ($12,000 this year slated to increase to $13,000 next year) it must be a gift now, not some gift in the future. As I mentioned above, when one makes a contribution to an ILIT to pay an insurance premium, that gift is generally considered a “future gift” since the insurance policy will not pay and the trust will not distribute to the beneficiaries until a future event, such as the death of the insured.
So the Crummey notice is designed to transform a “future” gift into a “present” gift by giving the beneficiaries the right to withdraw the funds for a stated period of time. Now the beneficiaries could thwart the ILIT planning by actually exercising their rights to withdraw the contributions, for if they do then the insurance policy may lapse for failure to pay the required premiums. Most grantors who establish ILITs are counting on the good sense of the beneficiaries not to withdraw their share of the contribution, since the amounts they would receive when the policy pays off should likely exceed the amounts they would withdraw under the Crummey notice.
Where I am going with all of this is that the IRS generally doesn’t ask any questions whether the Crummey notices were actually sent, that is, until the death of the grantor/insured. Then the IRS asks the questions. And if you don’t have a file full of Crummey notices each year dating back from the inception of the trust, your beneficiaries may find themselves in an argument with the IRS as to whether the contributions to the ILIT were gift tax free.
If the trustee for your ILIT doesn’t have a complete file containing all of the proper Crummey notices for your ILIT, its likely time to discuss that issue with your estate planning attorney. In the meantime, make sure that you have adequately hid your old high school yearbooks.