Rev. Rul. 85-88

1985-2 C.B. 201, 1985-26 I.R.B. 5.

TRANSFER IN TRUST; 'CRUMMEY' POWERS; RELINQUISHMENT OF WITHDRAWAL POWERS

Published: July 1, 1985

Section 2514.-Powers of Appointment, 26 CFR 25.2514-3: Powers of Appointment created after October 21, 1942

  Transfer in trust; 'Crummey' powers; relinquishment of withdrawal powers. Multiple or successive 'Crummey' withdrawal powers possessed by the beneficiary  of one trust or possessed by the beneficiary under the provisions of more than one trust are similarly required to be aggregated for purposes of the annual gift tax exemption.

ISSUE

  (1) For purposes of section 2514(e) of the Internal Revenue Code, does a taxable gift result from the successive lapses of two noncumulative powers to withdraw trust corpus held by a beneficiary of a trust in one calendar year?

  (2) For purposes of section 2514(e) of the Internal Revenue Code, what is the amount of the taxable gift that results from the lapse of a general power of appointment held by the income beneficiary in each of two identical trusts created by the same grantor under the circumstances described below?

FACTS

  SITUATION 1: In March 1982, G created an irrevocable trust under which § was granted the right to receive the trust income for S's life and C was granted the remainder interest. In addition, § was given the right under the trust to withdraw up to $5,000 from each contribution made by any donor to the trust.

  The trust instrument required the trustee to provide § with notice immediately on receipt of a contribution. § had the right for a period of 60 days following receipt of a notice to exercise the right of withdrawal, after which the right lapsed.

  G contributed $5,000 to the trust upon its creation. § was promptly notified of the contribution, but did not make a demand for withdrawal within the prescribed period. G made another $5,000 contribution in September 1982. Again, § was notified of the contribution, but the right of withdrawal subsequently lapsed within the year without § having exercised it.

  SITUATION 2: In February 1982, G created two irrevocable trusts under which § was named the life income beneficiary and C was designated as the remainderman.

  In addition to the life income interest, § was give a power in each trust to withdraw $5,000 of the contributions made by any donor in any calendar year. The powers given § were exercisable under the same conditions as the powers in Situation 1.

  When the trusts were created, G contributed $5,000 to each. § was promptly notified of the contributions, but did not make a demand for withdrawal with respect to either contribution within the prescribed period. No further contributions were made to either trust in 1982. The two trusts were at all times administered in all respects as separate trusts.

LAW AND ANALYSIS

  Section 2514(c) of the Code defines a general power of appointment as a power exercisable in favor of the possessor of the power, the possessor's estate, the possessor's creditors, or the creditors of the possessor's estate. Under section 2514(b) of the Code, the exercise or release of a general power of appointment created after October 21, 1942, is treated for federal gift tax purposes as a transfer of property by the individual possessing such power.

  Under section 2514(e) of the Code, the lapse of a general power of appointment created after October 21, 1942, like the release of such a power, results in a transfer for federal gift tax purposes. With respect to any calendar year, however, this rule applies only to the extent the value of the property subject to the lapsed powers exceeds the greater of $5,000 or 5 percent of the aggregate value of the assets ('5 and 5 exemption') out of which the exercise of the lapsed powers could have been satisfied. See section 25.2514-3(c)(4) of the Gift Tax Regulations.

  There is no indication in the legislative history of the predecessor of section 2514(e) (section 811(f)(4) of the 1939 Code) that Congress intended that the holder of multiple noncumulative general powers of appointment should receive more than one '5 and 5 exemption' in a calendar year. See S. Rep. No. 382, 82 Cong., 1st Sess. 6-7 (1951). Moreover, the language of section 2514(e), states that the exemption applies 'with respect to the lapse of POWERS during any calendar year.' (Emphasis added.) Thus, under these circumstances, only one 5 and 5 exemption under section 2514(e) is available for all lapses of powers of appointment in a single trust in a calendar year. Accordingly, the beneficiary is entitled to only one $5,000 exemption per calendar year.

  The 5 percent test of section 2514(e) is stated in terms of 'the aggregate value of the assets out of which, or the proceeds of which, the exercise of the lapsed powers could be satisfied.' For example, where a power of appointment is limited to annual trust income, the 5 percent test is based on annual trust income, not the amount of trust corpus. Fish v. United States, 291 F. Supp. 59 (D. Ore. 968), aff'd, 432 F.2d 1278 (9th Cir. 1970). The 5 percent test is based on the value of the assets subject to the power at the time of the lapse of the power. See section 25.2514-3(c)(4) of the Gift Tax Regulations. Where the donee has more than one noncumulative withdrawal power in the same trust that lapses in a calendar year, the 5 percent test is based on the maximum amount subject to the donee's withdrawal power on the date of lapse of any such power during the calendar year. Where the donee has noncumulative powers to withdraw property from two or more trusts, the 5 percent test is applied by aggregating the amount determined pursuant to the proceeding sentence for each such trust with respect to which the withdrawal power has lapsed during the calendar year.

  For example, suppose B has the power to withdraw $20,000 from the corpus of one trust, and the power lapses on June 1, when the trust corpus is worth $300,000. If B has a second noncumulative power to withdraw $20,000 from the corpus of the same trust, and such power lapses on December 1, when the value of the trust corpus has appreciated to $400,000, then the maximum amount of trust assets subject to B's withdrawal power at the time of any lapse during the calendar year would be $400,000, and the amount of B's 5-and-5 exemption for the year would be $20,000 (5% x $400,000). On the other hand, if B's second withdrawal power in the example is exercisable only with respect to a second, separate trust, B's 5-and-5 exemption for the year would be $35,000 (4% x $700,000).

  In SITUATION 1, S's powers of withdrawal were limited to contributions to the trust. Although each contribution creates a new withdrawal power and arguably provides a separate fund for the exercise of each such withdrawal power, only a single 5-and-5 exemption is available to § in 1982. Providing a separate 5-and-5 exemption for each contribution would undermine the statutory purposes to limit the exemption provided by section 2514(e). Moreover, section 2514(e) states the $5,000 and 5 percent tests in terms of the aggregate value of the assets out of which the exercise of the lapsed powers could be satisfied. Nothing is said concerning separate tests for each of the funds out of which the lapsed powers could have been exercised.

  In SITUATION 1, $10,000 was contributed to the trust in 1982. § did not exercise the powers of withdrawal and both powers lapsed within the year. Once a power lapsed, C acquired a vested interest in the amount subject to the lapse. Therefore, C received a remainder interest in $10,000 in 1982 as a result of the lapsed powers. The gift tax does not apply to the $5,000 portion of the trust property in which C has a remainder interest and which is covered by S's 5-and-5 exemption. However, to the extent of C's remainder interest in the excess portion ($10,000 - $5,000 = $5,000) of that property, the gift tax does apply.

  Accordingly, under section 2514(e) of the Code, § is treated as having made a gift to C of the excess $5,000 less the value of S's retained interest in the excess $5,000. The value of the taxable gift from § to C is computed as the difference between the $5,000 excess and the value of the right in § to receive the income for life from the excess $5,000.

  In SITUATION 2, the statutory purpose of section 2514(c) of the Code to provide a limited exemption to the general rule that lapses of powers of appointment carry the same transfer tax consequences as releases and exercises would be thwarted if multiple exemptions were allowed. The allowance of multiple 5-and-5 exemptions would be inconsistent with the purpose of the statute. Moreover, as discussed above section 2514(e) applies the 5-and-5 exemption to the aggregate value of the assets out of which the lapsed powers could have been satisfied. Permitting separate 5-and-5 exemptions for multiple trusts would elevate form over substance by providing more favorable treatment where a transfer to a trust is restructured as multiple transfers to separate trusts.

  Thus, in SITUATION 2, § is allowed one $5,000 exemption for the two powers that lapsed in 1982. As in SITUATION 1, § is considered to have made a gift to C of C's remainder interest in the $5,000 not covered by the exemption. In order to ensure that C's multiple powers are not treated less favorably than a single power in one trust fund, in SITUATION 2 the 5 percent test would be applied by aggregating the maximum amount in each trust subject to C's withdrawal powers with respect to such trust on the date of lapse of such powers during the calendar year.

HOLDINGS

  In both SITUATIONS 1 and 2, § is considered to have made a transfer for federal gift tax purposes as a result of the lapse of S's power to withdraw to the extent that the aggregate amount subject to S's powers exceeds the $5,000 exemption provided in section 2514(e) of the Code. In each situation, the amount taxable is $5,000 less the value of S's retained interest in that amount.

Rev. Rul. 85-88, 1985-2 C.B. 201, 1985-26 I.R.B. 5.