Any person currently may make a tax-free gift of up to $14,000 each year to anyone he or she wishes. One potential beneficiary of an annual exclusion gift is the donor’s spouse. This is often overlooked because the law allows an individual to make unlimited lifetime gifts to a spouse under the unlimited marital deduction. However, upon the donee spouse’s death, the assets transferred to the spouse under the unlimited marital deduction will be included in his or her estate and subject to estate tax.
Enter the Family Bank Trust. A Family Trust Bank Trust is an irrevocable trust created for the primary benefit of the grantor/donor’s spouse and designed to qualify for annual exclusion gifts. During the life of the grantor’s spouse, discretionary distributions can be made to the spouse. Additional beneficiaries, such as the grantor’s children, may also be named as initial beneficiaries during the donee spouse’s lifetime. (For simplicity sake, this post presumes that the donee spouse is the only initial beneficiary of the trust.) The trust is not designed to qualify for the unlimited marital gift tax deduction and is also designed not to be included in the grantor spouse’s estate.
To take advantage of annual gift tax exclusion, the donor creates an irrevocable trust to benefit the done spouse during his or her lifetime. The donee spouse may even be named as the trustee, given him or her access to the trust assets for needs related to health, education, maintenance and support. The trust assets remaining at the donee spouse’s death pass to children or other loved ones name as death beneficiaries, with the assets of the trust being excluded from the taxable estate of both spouses.
A transfer to a trust is normally considered to be a gift of a future interest, which triggers a gift tax because the gift tax annual exclusion applies only to gifts of present interests. The use of a Crummey withdrawal power in the trust, however, will qualify a gift for the gift tax annual exclusion. A Crummey power allows the donee spouse to withdraw the gifts during the 30 day period beginning when the gift is made to the trust. Because the donee spouse has the right to reduce the gift to his or her possession, should he or she choose to do so, the gift to the trust will be considered a present interest gift.
Although the gift tax exclusion is currently $14,000, for the first several years of the trust’s existence the annual gift to the trust must be limited to $5,000 when the spouse is the only lifetime beneficiary named. This is because whenever a Crummey power is used in a trust, the Crummey right has the legal effect of granting a general power of appointment to the demand beneficiary. Under the law, all property over which a person has a general power of appointment will be included in his or her taxable estate. There is an exception to this rule, whereby if the right to withdraw does not exceed the greater of $5,000 or 5% of the trust corpus, no estate tax inclusion results. Since the trust’s objective is to remove property gifted to the trust from the taxable estates of both spouses, annual gifts to the trust should not exceed the greater of $5,000 or 5% of the trust corpus. This means that until the trust exceeds $100,000 in value in this example, the donor may make only a gift of $5,000 per year. Once the value of the trust exceeds $100,000, the donor may make a gift equal to 5% of the trust value, but not to exceed the gift tax annual exclusion amount.
A significant benefit the donor achieves by setting up a Family Bank Trust is the ability to transfer future appreciation on property placed in the trust free of gift and estate tax. Because a transfer to a Family Bank Trust is a completed gift for gift tax purposes, once the property is placed in the trust the principal amount and all future growth on the property will be excluded from both spouses’ taxable estates.