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5/5 lapse rule


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#1 Caramelly

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Posted 21 August 2009 - 06:02 AM

I have 3 questions regarding the 5/5 lapse rule.  My understanding is that if someone makes an annual contribution of $26,000 to a trust with 2 beneficiaries, they are able to take the annual exclusion of $13,000 as long as they send the beneficiaries a crummey letter making it a gift of present interest.  However if one of the beneficiaries allows it to lapse, they are giving the other beneficiary a gift of $13,000-$5,000 = $8000/2=$4,000. 


1) Am I correct in assuming that the beneficiary does not have to submit a git tax return since the amount is <$13,000?


2) Am I correct in assuming that if the person making the contribution only allowed the beneficiaries to take $5,000 each, he would have only been able to take the annual exclusion of $5,000 x 2 = $10,000 which means he would have to complete a gift tax return for the other $16,000 but now the beneficiaries will not have a taxable gift if they allow it to lapse?


3) Is this a common problem and how can it be avoided?



#2 pg1067

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Posted 21 August 2009 - 09:11 AM

Your references to a rule and an exclusion make little sense since you didn't identify the applicable state.  Nor did you describe the type of trust at issue.

#3 Caramelly

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Posted 21 August 2009 - 09:39 AM

I am talking about Federal Estate Tax law only.

#4 Caramelly

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Posted 21 August 2009 - 09:42 AM

Also, my understanding is that the type of trust is irrelevant.  Okay so say that it is an ILIT.  The issue is that you can not take the annual exclusion for a gift of future interest which is why you send a crummy letter to the beneficiaries making it a present interest.  This is all under the federal statute.  If you think I am completely wrong, please let me know.

#5 Tax_Counsel

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Posted 23 August 2009 - 02:36 AM

"My understanding is that if someone makes an annual contribution of
$26,000 to a trust with 2 beneficiaries, they are able to take the
annual exclusion of $13,000 as long as they send the beneficiaries a
crummey letter making it a gift of present interest."

That depends on the terms of the trust, which we don't have here. It is possible that the entire amount would qualify for the annual exclusion, but the details really do matter.

"1) Am I correct in assuming that the beneficiary does not have to submit a git tax return since the amount is <$13,000?"

No. The lapsed gift itself is likely a gift of a future interest, since the other beneficiary will not have an immediate right of withdrawal. Gifts of future interests are not included in the $13,000 annual gift tax exclusion. Thus, the gift is likely a taxable gift, requiring the filing of a gift tax return by the beneficiary and reduction of his gift and estate tax credits, or payment of tax if the gift tax credit has been exhausted. Again, the details of how this is set up matter greatly.

"2) Am I correct in assuming that if the person making the contribution
only allowed the beneficiaries to take $5,000 each, he would have only
been able to take the annual exclusion of $5,000 x 2 = $10,000 which
means he would have to complete a gift tax return for the other $16,000
but now the beneficiaries will not have a taxable gift if they allow it
to lapse?"

You are correct that the donor now has a taxable gift and must file a gift tax return. The amount of the taxable gift will again depend on the terms of the trust, as that will bear on how the exclusion will apply. But the beneficiaries would now not have a taxable gift and would not have to file a gift tax return nor use up any of their estate and gift tax credits.

"3) Is this a common problem and how can it be avoided?"

It is a common problem with gifts to trusts that have two or more beneficiaries where the Crummey device or other powers of appointment are present. The extent to which it can be avoided depends on the details of the proposed trust. There are several possible ways to deal with this problem, but a full discussion of it is beyond the scope of a message board forum like this one. I suggest you see a tax attorney or estate planning attorney with familiarity with the gift tax rules for assistance with this. There are all kinds of traps for the unwary in setting up trusts like this, so it is not a good do-it-yourself kind of project.





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