BILL NUMBER: S6065

SPONSOR: HOYLMAN
 
TITLE OF BILL:

An act to amend the estates, powers and trusts law and the civil prac-
tice law and rules, in relation to clarifying and declaring as the
existing law of the state of New York the provisions of rules relating
to the lapse of a power of withdrawal over the income or principal of a
trust

 
PURPOSE OR GENERAL IDEA OF BILL:

This bill clarifies and declares the existing law of the state of New
York; the provisions of rules relating to the lapse of a power of with-
drawal over the income of a trust.

 
SUMMARY OF PROVISIONS:

These amendments amend section § 7-3.1 of the Estates, Powers and Trusts
Law and section 5205 of the Civil Practice Law and Rules to clarify and
              

declare as the existing law of the State of New York that a beneficiary
of a trust does not become the settlor of the trust merely because of a
lapse of the beneficiary's right to withdraw trust property.

 
JUSTIFICATION:

One of the most widely used estate tax planning devices is the "irrev-
ocable life insurance trust." In order to avoid estate tax inclusion of
the death benefit payable under a life insurance policy, many opt to
have the policy owned by an irrevocable trust. As long as the trust is
funded with a new policy, or the grantor transferred his or her existing
policy into the trust prior to three years before death, the proceeds
will escape estate tax.

Once the trust is in place, the grantor typically gives the trustee
money for the trust to pay the life insurance premiums. This transfer of
property to the trust is considered to be a gift to the beneficiaries
(usually the grantor's children and/or grandchildren).  In order for the
grantor to be able to utilize his or her annual exclusions from federal
gift tax (currently $11,000 per donee), the beneficiaries must be given
a present interest in the property transferred to the trust. This is
usually accomplished by giving the beneficiaries a limited power of
appointment that permits the beneficiary to elect to withdraw the great-
er of $5,000 or 5% of contributions made to the trust each year (but not
exceeding $11,000). These powers of withdrawal are referred to "Crummey"
powers in light of the discussion in Crummey v. Comer, 397 F.2d 82 (9th
Cir.  1968). The IRS in Rev. Rul. 73-405, 1973-2 C.B. 321 has assented
to the legitimacy of the arrangement.

The power of withdrawal causes a beneficiary to be deemed the owner of
the property for federal estate tax and gift tax purposes. Normally,
this would mean that the property subject to the power would be included
in the estates of beneficiaries. However, the Internal Revenue Code (S
2041(b)(2) and2514(e)) permits the power of withdrawal to lapse if not
exercised by the beneficiary.

Thus, gifts to a life insurance trust may qualify for the gift tax annu-
al exclusion by granting the trust beneficiaries powers of withdrawal,
which will lapse without tax consequence to the beneficiary if he or she
(hopefully) does not exercise the withdrawal power.

It is at this juncture that an ambiguity in New York State law may cause
a problem for the beneficiaries. EPTL § 7-3.1 and CPLR § 5205 provide
that contributions to a self-settled trust are permanently subject to
the grantor's creditors. Applied to the life insurance example, the
concern is that a beneficiary whose power of withdrawal lapses will be
treated as a "grantor" with respect to the property "contributed" by
virtue of the unexercised or lapsed withdrawal power.  This would
theoretically allow the beneficiary's creditors to access the lapsed
withdrawals. This, in turn, could result in estate tax inclusion,
notwithstanding the lapse protections of Internal Revenue Code §§ (2041
(b)(2) and 2514(e)). This is because IRC Section 2041 provides that
property subjected to a "general power of appointment" is includable in
one's estate. For estate tax purposes, a general power of appointment is
defined, in part, as property that a power holder can appoint to his or
her creditors. In this context, NYEPTL § 7-3.1 could potentially allow a
beneficiary's creditors to attach property over which the beneficiary
has the power to withdraw. It is the lapse of this power which can cause
a beneficiary to be treated as the grantor of a self-settled trust.

Thus, subject to creditor claims under state law, the beneficiary is
deemed to have a general power of appointment over the property, which
will, in turn, subject it to inclusion in his or her estate.

In order to avoid this result, New York State law should be clarified to
provide that our creditors rights' doctrine does not apply to property
contributed to a trust merely by reason of a lapse, waiver, or release
of a power of withdrawal valued at less than 5% of the aggregate value
of the trust.

Without this clarification, estate planning attorneys may be hard
pressed not to suggest that an irrevocable life insurance trust be
created under the laws of such states as AK, DE, NE or TX which do not
pose the possible dangers described herein.

 
PRIOR LEGISLATIVE HISTORY:

02/09/17 referred to judiciary
01/03/18 referred to judiciary

 
FISCAL IMPLICATIONS:

none

 
EFFECTIVE DATE:
This act shall take effect immediately and shall be enforceable as to
all trusts created under New York law, regardless of when created, as it
is declaratory of existing New York law.