What is the Annual Gift Tax Exclusion?
The annual gift tax exclusion (typically called the “annual exclusion”) is a fixed dollar amount that can be given to as many people as a person wants each year without using up unified credit or causing a gift tax to be due. The amount of the annual exclusion has changed over time. In 2023 the annual exclusion amount is $17,000 and is only available for lifetime gifts (not at death).
Making Annual Exclusion Gifts to Trusts Can Be Complicated
We know the dollar amount of the annual exclusion. However, there is another important rule – it is only available for a gift of a present interest. The “present interest rule” is a law that enables the IRS to identify (or count) how many beneficiaries are receiving the gift so that the IRS knows how many annual exclusions are available to the taxpayer (“donor”) making the gift.
It’s easy to count the number of annual exclusions available for a direct gift to a person – any gift to a person (the “donee”) is a gift of a present interest because the donee can spend the money immediately. For example, if father gives daughter $17,000, one annual exclusion is available. If mother gives that same daughter $17,000, another annual exclusion is available. And if grandmother also gives that same (grand) daughter $17,000, another annual exclusion is available.
But what about gifts to trusts? A different rule applies. Assume parent creates a trust for the benefit of daughter, and at her death, for her two children. The trust terms provide that the trustee may pay such amounts to the daughter as she needs for her support, health, maintenance, and education, and at her death, payments to her children may be made for the same purposes. If parent makes a gift to the trust, is one annual exclusion available – or three?
The answer is the annual exclusion gift isn’t available because gifts to trust aren’t gifts of present interests! There is, however, a way to make the annual exclusion available for gifts to trusts like the one in the example above.
In the late 1970s, a taxpayer had a minor child and decided to make an annual exclusion gift to a trust for the child’s benefit (retaining the funds in the hands of a trustee until the child was old enough). The taxpayer was told the gift would not qualify for the annual exclusion. The taxpayer wanted to avail himself of the annual exclusion, so a provision was included giving the minor child the “right to withdraw the funds” (contributed by the taxpayer) for 30 days after the contribution. By including such a provision in the trust, the purpose was to change a “future interest” (disallowing the annual exclusion) into a “present interest” (allowing the annual exclusion).
The IRS denied the annual exclusion; but on appeal, the Ninth Circuit held the annual exclusion should be available to the taxpayer. That taxpayer’s name was Dr. Crummey. And today, most irrevocable trusts include a right to withdraw (commonly called a “Crummey power”) in order to convert future interests into present interests – making the annual exclusion available for gifts to a trust.
In our example, when a trust is created for the benefit of daughter and her two children, if a Crummey power is inserted for all three of the beneficiaries, then three annual exclusions will be available. The Crummey power makes all three gifts “present interests” – in other words, it’s easy to “count” the number of trust beneficiaries and therefore the number of annual exclusions available to the taxpayer when gifts are made to the trust (1).
2503(c) Trusts are specific types of trusts, gifts to which qualify for the annual gift tax exclusion, and a Crummey power is not necessary – because a 2503(c) Trust requires that assets be available to the child immediately (e.g., for support) and distributed outright at age 21. If there is a substantial sum that might be present in a trust of this nature, age 21 is likely too early for a child to receive trust assets. For this reason, 2503(c) Trusts are not used very often.
Accounts Under the Uniform Transfers to Minors Act (UTMA)
Gifts to “UTMA” accounts do qualify for the annual exclusion as gifts of present interests. However, if created when the donor is alive, these accounts (like 2503(c) Trusts) must also be distributed to children at age 21 – raising the same types of issues (2).
(1) There are many complications and technical rules related to the Crummey power and a qualified attorney should be consulted for this planning.
(2) Note that UTMA accounts may be payable outright at age 18 unless the account is notated upon opening that distribution should occur at age 21