Must a Beneficiary Be Notified of Premium Payments On a Trust Owned Policy? What’s Adequate Notice?

Situation: One of the first techniques typically used for estate tax reduction and liquidity is the irrevocable life insurance trust, or ILIT. If properly structured, the life insurance policy proceeds are received estate tax-free by the ILIT. In addition, properly structured and administered contributions of funds to the trust to cover the policy pre­miums can be gift-tax free. Because ILITs are one of the most frequently used estate techniques, they also gen­erate the most questions. One broad area of questions deals with the notice requirements for premiums con­tributed to the trust. Specifically, must a trust beneficiary be notified of premium contributions made to the trust, what type of notice must be given to the trust beneficia­ries, and can future notices be waived? This Counselor’s Corner addresses the quandary around adequate notice.

Solution: Generally, beneficiaries must be notified of con­tributions to a trust. Before addressing the type of notice required, it’s important to understand why it’s necessary to provide beneficiaries notice in the first place.

Why must the trust beneficiaries be notified of premium contributions to the trust? We are all aware that for an individual (donor) the first $19,000 (2025 indexed) of gifts of a “present interest” in property to any person (donee) during a calendar year qualifies for the gift tax annual exclusion. There is no limit to the number of annual ex­clusion gifts that a donor can make in a year, or over his/ her lifetime. So, for example, if Warren Buffett gave ev­eryone in the city of Chaska (where this author resides) a $19,000 gift he would not incur any gift tax. Furthermore, this amount can be increased to $38,000 if his spouse, Astrid, elects gift splitting. The annual exclusion does not apply to gifts of a “future interest.” A gift is classified as a future interest if the beneficiaries’ possession, use, or enjoyment of the transferred property is deferred to a later time.

Many individuals/donors that want to take advantage of the annual exclusion are unwilling to place substantial sums of money at the immediate disposal of their intend­ed beneficiaries. As a result, an irrevocable trust is often established to maintain some degree of control over the assets transferred until some specified time in the future. Since the primary purpose of using the trust is to postpone the beneficiaries’ immediate enjoyment of the property, the transfers will generally be gifts of a future interest and not eligible for the gift tax annual exclusion. However, it is possible to create a trust where contribu­tions will be considered present interest gifts.

One way to overcome the future interest problem inher­ent in transfers to a trust is to grant the trust beneficiaries a Crummey withdrawal right. When a grantor gives a trust beneficiary a Crummey right he is giving the individual the right to withdraw transfers to the trust for a limited period of time. As long as the Crummey right is properly administered, the grantor’s cash transfers to the trust will be treated as present interest gifts that qualify for the gift tax annual exclusion. The timing and process of providing notice to beneficiaries who hold Crummey withdrawal rights in a trust is a crucial step in ensuring that any trans­fers to the trust will qualify for the grantor’s annual gift tax exclusion.

Even though it may be unlikely that any of the beneficia­ries will exercise their Crummey withdrawal rights, the power, nevertheless, cannot be illusory. If the beneficia­ries do not receive adequate knowledge of their rights or the time period to withdraw is too short, the power may be considered a sham, and the transfer deemed a taxable gift by the Internal Revenue Service (IRS). Consequently, it’s clear that the trustee must provide adequate notice to the ILIT Crummey beneficiaries of premium contribu­tions to the trust to qualify for annual exclusion gift tax treatment. This brings us to the question at hand. What is adequate notice?

Adequate notice to the Crummey power holder. In Rev. Rul. 81-7, 1981-1 C.B. 474, the IRS stated that Crummey beneficiaries must be aware of the existence of the with­drawal right and be given a reasonable opportunity after the notice to exercise their demand right before it lapses. Thus, practitioners should require that the trustee give beneficiaries prompt notice of the contributions to the trust as well as their right to withdraw those contributions to ensure the transfers will qualify for the annual gift tax exclusion.

No revenue rulings or private letter rulings (PLRs) have required that notification of the right to withdraw a contri­bution must be given in a particular manner. PLR 8008040, 8022048 and 9030005 state that “actual notice” is all that is required. Rev. Rul. 83-108 and PLR 199912016 spoke of “reasonable” notice to the beneficiary. Thus, it appears oral notification would suffice; however, since the taxpayer has the burden of proof, written notice would be the more conservative approach. Notification is best accomplished by certified mail, return receipt requested, or in some manner that shows both delivery and receipt of delivery.

Another issue frequently discussed is “timeliness.” To qualify for the annual gift tax exclusion, the donee must have an “unrestricted right to immediate use, possession or enjoyment” of the gifted property. The question arises, if the trustee receives a transfer of property to the trust but unreasonably delays providing notice to the beneficia­ries, does an immediate right of withdrawal exist? In Rev. Rul. 83-108, where the trust document allowed the trustee ten days to notify the beneficiary of the withdrawal right, the IRS held that the annual exclusion was available. In PLR 9311021, where “prompt notice” was required by the trust document and the beneficiary was given sufficient time to act, a present interest was found. PLRs 9812006, 9810006, 9810007, 9810008, and 9745010 all required “immediate notice” to the power holders and the IRS determined in each one that the transfers to the trust qualified for the annual exclusion. To ensure that the contributions will qualify for the annual exclusion regardless of whether the trust document requires “prompt notice,” “immediate notice,” etc., the trustees should be advised of the need to give notice as soon as possible.

Waiver of future notices – the “one-time” notice. This is a controversial area. Although PLRs 8143045, 8133070, 8138102, and 8121069 all address the issue of a one-time notice (which identified future contributions) that received IRS approval, the following discussion illustrates that this is an unsettled area. In PLR 8121069, the trust­ee was required to give each beneficiary personal notice when a new contribution was made to the trust. The trust document directed the trustee to prepare a single letter notice for each beneficiary setting out the amount of the insurance premiums, their due dates, the amount of the contribution, and the terms of the withdrawal rights. This notice was intended to be a continuing notice with respect to the insurance policies covered by it. The additions to the trust were considered present interest gifts. However, in Technical Advice Memorandum (TAM) 9532001, where the power holders received notification of an initial gift made to the trust in 1992 and then waived their rights to future notification of gifts transferred in 1993 through 1996, the IRS held that these later gifts were future interest gifts and failed to qualify for the annual gift tax exclusion. Although commentators argue that the law does not support this position, the conservative stance is to give annual notifica­tion of transfers to the trust.

As a result of this TAM, commentators question whether notices are required with each trust contribution if those

contributions are more frequent than annually. Many legal advisors now avoid the issue by drafting documents to pro­vide for annual transfers only. Where transfers to the trust are more frequent, some follow the facts in PLR 8121069 and give notice with each contribution. Others use an annual notice with a detailed schedule of the monthly, quarterly, or other transfers.

How long before a lapse of the Crummey power should notice be given? Although the IRS hasn’t issued a defini­tive answer, the IRS has indicated in several private letter rulings that thirty days between the notice of withdrawal and the lapse of the right to demand the addition to the trust was an adequate time period. Additionally, in PLR 8022048, the IRS implied that anything less than thirty days is too short of a notification period. However, in Cristofani, the Tax Court ruled that transfers of property to a trust in which the beneficiaries possessed the right to make withdrawals within 15 days of the notice qualified for the annual gift tax exclusion.3 In Rev. Rul. 83-108, 1983-2 C.B. 167, the IRS ruled that even where the withdrawal period extended into the next year, the annual gift tax exclusion was available for the current year (i.e., the year the contribu­tion was made to the trust).

In Summary. Although much of the law cited in the above summary doesn’t necessarily set precedents, it provides in­sight into the IRS viewpoint and can be used as a guide. At a minimum, the following should be considered when drafting Crummey notifications:

• Written Notice. Although written notice is not required, it provides a “paper trail” that proper notification was made and trust beneficiaries were informed of their rights.
• Annual Notice. To avoid the implication that “current notice” was not given, legal advisors should avoid the use of a “one-time” notice and give at least annual notice of withdrawal rights.
• Adequate Notice. Care should be taken to draft the notice so that it provides precise and sufficient information to the beneficiaries as to their rights, the time they can exercise them, the actions needed to exercise, etc.
• Timely Notice. The trustee should be advised to give notice as soon as possible after a transfer is made to the trust, and the beneficiary should be given reasonable time to exercise his or her withdrawal right before the power lapses.