Religious Arbitration Clause Does Not Hurt Million Plus Gift Tax Exclusion

This post was originally published on Forbes May 11, 2015

There was one estate planner who had a stroke of marketing brilliance a long time ago.  He or she decided that we should call death insurance life insurance.  Since then estate planners have not done that well with names.  They tell people they should have trusts that are defective or crummy.  Just doesn't sound good.

Actually the trusts are Crummey trusts named after one D. Clifford Crummey who won a decision in the Ninth Circuit in 1968, when I was just a high school lad.  Israel and Erna Mikel were just in Tax Court showing how powerful the Crummey power can be as they used it to shelter over $1.4 million in transfers to their family trust from gift taxes.  An arbitration clause that called for the use of a religious court caused the IRS to challenge the validity of the exclusions, but the Tax Court ruled in the taxpayer's favor.

Crummey Power

There is an annual exclusion from gift tax.  Every year you can give the annual exclusion amount ($14,000 in 2015) to as many people as you want without incurring gift tax or eating into the unified credit against transfer taxes.  There is a catch, though.  In order to qualify for the exclusion, the gift has to be of a "present interest".

Often when you are making gifts to the kids and grandkids and if you are really generous nephews and nieces and maybe even people whose blog you enjoy (Just saying), you don't want to give it to them outright, you want the money in the hands of a trustee who will dole it out to them responsibly. "Put not your trust in money, but put your money in trust."  It gets a little technical, but that is more or less the antithesis of a "present interest". It makes for a bit of dilemma.

The Crummey power is a way around the dilemma.  Money or property goes into the trust and the trustee is instructed to notify the beneficiaries who have a brief time in which they are allowed to withdraw up to the annual exclusion amount.  Beneficiaries are very much discouraged from exercising that power. I've never heard of one actually doing it.  Still, it is something that people worry about it.  Enough so they will put provisions in the trust to discourage the beneficiaries from having the temerity to exercise their withdrawal rights.  Sometimes the IRS will argue that the discouragements are discouraging enough to make the withdrawal rights not meaningful.

The Mikel Case

Israel and Erna Mikel each made gifts to a family trust with an "asserted value" of $1,631,000.  They each claimed annual exclusions in the amount of $720,000.  The annual exclusion in 2007 was $12,000. So that means 60 different people had withdrawal rights. According to the decision, they were all lineal descendants or spouses of descendants. Big family, I guess.   The IRS disallowed the exclusions claiming that the beneficiaries lacked legally enforceable rights to withdraw the funds.

Once the Crummey power lapsed, there was no guarantee that any particular beneficiary would get anything from the trust

Apart from directing mandatory distributions in response to withdrawal demands, the trust empowered the trustees, “in their sole and absolute discretion,” to make discretionary distributions during the term of the trust. Such distributions could be made for the health, education, maintenance, or support of any beneficiary or family member. Such distributions could also be made, in the trustees' “absolute and unreviewable discretion,” to assist a beneficiary in defraying “reasonable wedding costs, *** purchasing a primary residence, or *** entering a trade or profession.” In exercising this discretion the trustees were empowered to distribute “at any time and from time to time, any amount of income or principal (even to the extent of all).” The declaration specifies that “[t]he judgment of the Trustees as to the amounts of such payments and the advisability thereof shall be final and conclusive” upon all beneficiaries and other persons interested in the trust.

Rabbis And No Soup For You

The trust provided that any disputes concerning the interpretation of its terms would be submitted before a panel consisting of three persons of the Orthodox Jewish faith.  Such a panel is called a Beth Din.  I found that there is an organization called Beth Din of America which was founded in 1960 by the Rabbinical Council of America.  It became autonomous in 1994.  No financial data  on guidestar.org since it is classified as a church.  There is a legal journal with published decisions.

There is also a provision in the trust that if a beneficiary goes into court to oppose a distribution of the trust, any interest that beneficiary has will be revoked. This is called an "in terrorem" clause.  I kind of think of it as a "No soup for you" clause.

The IRS argues that the withdrawal rights were not "legally enforceable".  IRS starts out "hypothesizing that the trustees might refuse, without legal basis, to honor a timely withdrawal demand".  It admits that this an adverse ruling by the Ben Din could be appealed to state courts, even though the courts don't like to upset arbitration decisions.  The sense is that the "No soup for you" clause would scare them.  

The Tax Court read the trust more closely and thought that the "ad terrorem" clause was much more limited.  Basically, it was there to emphasize the trustee's broad discretion to make distribution and would only be triggered if a beneficiary brought a suit that challenged an actual distribution to another beneficiary.  Therefore the beneficiary did have an enforceable right to demand a distribution during the Crummey window.  As with any upholding of Crummey powers, the fact that it appears that beneficiaries never do that, as far as anybody I have ever heard of knows, is not relevant.

Will We Be Hearing More?

This decision was a partial summary judgment, so I suspect that the IRS and the Mikels are still duking it out about valuation.  The trust was funded with their residence in Brooklyn, two other properties in Brooklyn and a condominium in Florida.  Sixty beneficiaries who are lineal descendants or spouses seems on the high side, but if they are old enough to have some great-grandchildren, you can get there just with big families not necessarily enormous ones.  It makes me think that there might also be some generation-skipping tax issues involved.  You have to jump through some hoops to get a Crummey gift to qualify as a direct skip.

Other Coverage

Juan Antunez in the Florida Probate & Trust Litigation Blog writes that this decision is good news for advocates of faith-based arbitration clauses in estate planning documents. Apparently it is a pretty ecumenical movement.

Faith-based arbitration clauses are especially well suited to inheritance disputes. And not only are they legally enforceable, they’re growing in popularity. Hundreds of Christian denominations and organizations offer this kind of dispute resolution service. Peacemaker Ministries, founded in 1982, is reportedly the largest. The Jewish arbitration system is perhaps the most well organized, with branches of standing battei din all over the country. Headquartered in New York and founded in 1960, the Beth Din of America is the most prominent. Although less organized and widespread than Jewish and Christian dispute resolution services, Islamic organizations also offer mediation and arbitration services ...

The last of those is the source of some of the rumors that Sharia law is about to take hold in the United States.

Charles Rubin also covered the decision.

So the IRS argued that the in terrorem clause effectively voided the withdrawal beneficiaries power to legally enforce his or her withdrawal powers – thus they were illusory and not a qualified present interest.
The flaw in this argument is that the beth din was still obligated to apply the provisions of the trust instrument and New York law. So since the beneficiaries had withdrawal rights under the trust and New York law the beth din could not willy-nilly disregard them – the rights were thus enforceable. The fact that they were enforceable by the beth din and not a court of law was not important to the Tax Court.

Ed Morrow notes that the decision may provide ammunition for an administration proposal that would simplify things by eliminating the "present interest" requirement, but at the same time limiting annual exclusion gifts to $50,000 per donor.

Lew Taishoff covered the case with a cleverly titled post - A Crummey Ending.

 IRS has acquiesced in Crummey for years, but now claims the in terrorem frustrates any demanding beneficiary from pursing their rights, so the demand right is illusory. No, says Judge Lauber, the Beit Din remains and isn’t covered by the in terrorem. Anyway, reading the in terrorem, it applies only when someone challenges the trustees when they give away, not when they refuse.