Not All Trusts Are Created Equal

In a previous Acorn, we looked at the holding in Mikel v. Commissioner, a Tax Court case in which the IRS lost yet trusteeanother attempt to defeat Crummey powers.  “Crummey powers” (so named after the landmark 1960’s tax case,
Crummey v. Commissioner) you may recall, are withdrawal powers built in to a family trust that permit one gift tax annual exclusion to be claimed for each trust beneficiary.

Crummey Powers Revisited

To be eligible for the gift tax annual exclusion (currently $14,000 per gift), a gift must be of a “present interest” – i.e., a presently exercisable right, not just potential access in the future.  So a gift to a typical trust for my daughter is not a present interest, because my daughter cannot access the gift unless and until the trustee makes a distribution.  But if the trust (or the document making the gift) gives her a Crummey withdrawal power, my gift to the trust is converted into a present interest.  Because my daughter is given, say, a 30-day period to withdraw the amount of the gift, she has a presently exercisable right to the gift.  Add a few more beneficiaries and this becomes a powerful gifting tool; often it is leveraged further with life insurance.  In Mikel, the Tax Court blessed a Crummey trust having 60 beneficiaries, generating $720,000 per year in gift-tax-free annual exclusion gifts (the annual exclusion amount for the year in question was $12,000).

A String of IRS Failures, and Yet…

As noted in the prior Acorn article, the IRS has failed spectacularly in its litigation to invalidate Crummey powers over the years.  And in Mikel it found another way to lose.  But a recent development in the Mikel case brings another important point to the fore.  Just last week, the same Tax Court judge who awarded the Mikel family the resounding Crummey power victory discussed in the prior Acorn article, ruled for the IRS on an important issue.  Given the Court’s unequivocal earlier ruling, the Mikel family asked the court to charge the IRS with the family’s litigation costs.  The Tax Court said no.  The Court agreed with the IRS that “the trust document’s lack of clarity” gave substantial justification for the IRS position.  The judge noted that although the Mikels were the “prevailing party”, the trust clauses in question were “not a paragon of draftsmanship”.  In tax cases, as long as the IRS is “substantially justified,” the taxpayer pays his/her own way.  The gifts in the Mikel case were made in 2007.  Eight years later, after likely many tens of thousands of dollars in costs, the Mikels have a Pyrrhic victory at best.

Don’t Be the Test Case

So while we can thank the Mikel family for another Crummey power victory against the IRS, perhaps the larger lesson is: don’t be the test case.  At issue in the Mikel trust was a clause that attempted to give a withdrawal power but make it’s actual use nearly impossible – a “cake and eat it too” clause that the IRS decided was too cute.

Careful drafting of trust documents is critical.  Often in planning sophisticated or substantial gifting strategies it’s easy to get hung up on the calculations and the cash flow.  The documents can be an afterthought (“don’t you have a form you can just print out?”).  However, the Mikel case makes the importance of prudent and precise drafting all too clear.


 

About Oakstone Law, PL

Oakstone Law PL was founded by Bob Kleinknecht. A member of the Florida Family Trust Company Subcommittee, the Estate Tax & Trust Planning (ETTP) Committee and the Real Property, Probate & Trust Law (RPPTL) Section of the Florida Bar, Kleinknecht has 15 years’ experience.

Prior to founding Oakstone law, he spent more than eight years serving as a personal, in-house estate, tax and charitable planning attorney for a Forbes 400 family in New York and Florida. Before that he was an estate planning and estate settlement attorney with prominent firms in Boston and Washington, D.C. after beginning his career with a boutique firm in Naples, Florida.

Licensed in Florida and Massachusetts, Kleinknecht has developed a practice model that eliminates billing by the hour and offers a streamlined, customized client process supported by technology, security and a personal approach.

For more information on Oakstone Law, click here. To get in touch with us, click here to send us an email, or call 239-206-3454. Our office is located at 5137 Castello Drive, Suite 2 in Naples, Florida 34103.

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Oakstone Law
1415 Panther Lane, Suite 439
Naples, Florida 34109
Tel: 239.206.3454