Saturday, July 1, 2006

ILITS: Keeping “Crummey” Trusts from turning “Crummy.”

Financial advisors get to “sell the sizzle” of Irrevocable Life Insurance Trusts (ILIT) and their powerful estate tax avoiding leverage.  These trusts are a powerful tool which can provide your clients with near-unlimited estate tax savings, compounding their already impressive income tax free nature.

As simple as this technique is to illustrate, however, it is fraught with “devil in the details” issues.  First, a client must understand that, in order for transfers to the ILIT to be a completed gift (which is essential to the success of the technique), they must issue a so-called Crummey Notice (after the Crummey vs. Commissioner case) to each trust beneficiary each time they transfer funds to the trust.  This is an IRS - imposed rule, but clearly not one to be taken lightly, as the IRS has made clear in its acquiescence, that they will be asking for proof in the nature of copies of these notices, and proof they were sent.  This is an annual -- or more often-- hassle, which clients do not always understand when the technique is initially proposed.  The notice is just that--a notice.  The beneficiary must not sign anything that amounts to a “waiver” of their withdrawal rights.  Second, the client needs to clearly understand that the nature of the crummey notice is that they have the legal right to withdraw a portion of the monies transferred to the trust.  The client needs to know there is a very real risk that the beneficiary might exercise this right!

Third, the premiums on the insurance policy must be paid by the Trustee -- not by the grantor.  This has been the subject of litigation and it is not clear that the IRS has won on this issue.  But it is clear that they believe it to be an issue.  Best not to tempt fate.  

Fourth, because this is an irrevocable trust, it may have to report to the IRS on Form 1041 Income Tax Return..  As a general rule, life insurance (the main asset within the trust) does not earn “income” and this asset will not make reporting necessary.  However, in order for the Trustee to pay the premiums, the Trust will need a bank account.  Unless this is a non-interest bearing account (which we often recommend, in spite of the forbearance of interest), there may be taxable income, which triggers the reporting requirement.

These are all details which may “break” the trust if not properly attended to.  It is important, when advising clients, that they be made aware of the importance of these details, and the need to maintain vigilant observance during the life of the trust.

This Newsletter is intended to be informational, only and does not constitute legal advice.  If you have questions, concerns or comments, please contact me at:, or by Telephone at 989-652-9923.

Andy Richards


About Issues For Advisors

About 3 years ago, I started publishing a Quarterly E-Newsletter targeted directly at professional colleagues and valued referral sources. The intent of the newsletter was to be a resource for professional advisors, including Accountants, Insurance Professionals, Financial Planners, Brokers, Bankers and Planned Giving professionals. The "Issues For Advisors," newsletters have 2 primary goals: (1) To provide timely, useful information about issues that are either of current significance, have caused a recent problem, or are of a recurring nature to our mutual clients, and (2) To keep the content brief (no more than a single page). It recently occurred to me that there is no "archive" where advisors can go to retrieve, or re-read prior Issues. Rather than "burying" them somewhere in the Smith Bovill website, I created an on-line Resource specifically dedicated to the Professional Advisors enumerated above. In addition to the "Issues For Advisors" Archive, Links to other resources (including, of course, the MICHIGAN ESTATE PLANNING BLOG and THE SMITH BOVILL LAW FIRM SITE), will be featured here.

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