Recent rulings illustrate use of joint tenancy disclaimers in postmortem estate planning.

The IRS recently issued two letter rulings that confirm its new, liberalized position on disclaimers of a decedent's interest in certain jointly owned property. The Service's new position opens the door to postmortem estate planning in situations in which joint tenancies with right of survivorship or tenancies by the entirety would otherwise have undesirable estate tax consequences.

Joint tenancy

may be inappropriate

The typical form of home ownership among married couples is a joint'tenancy with right of survivorship or, in some states, a tenancy by the entirety. In either case, each spouse owns an undivided interest in the property - and on the first spouse's death, the entire property automatically passes to the survivor. This survivorship feature makes joint tenancy one of the simplest ways of transferring an interest in property. In some situations, however, the surviving spouse's estate may pay a high price in transfer taxes for that simplicity. Although the unlimited marital deduction ensures that the home will pass to the survivor free of any transfer taxes, the property will be subject to estate tax in the survivor's estate. For estate planning purposes, it may make more sense to have the first spouse's interest pass to a nonmarital or family trust or to other persons. In such cases, the first spouse's estate will escape estate tax on that interest through use of the unified credit, while the survivor's estate will avoid estate tax on that interest because it is not part of the survivor's estate.

Occasionally, the surviving spouse will not be aware of the possible adverse estate tax consequences of a joint tenancy until after the first spouse's death. By executing a qualified disclaimer of the deceased spouse's interest in

the joint tenancy property, the interest will not pass to the survivor and, therefore, will not be part of the surviving spouse's estate. The survivor will retain only the one-half interest in the property that he held prior to the decedent's death.

Qualified disclaimers

Sec. 2518 allows a would-be beneficiary to disclaim a gift or bequest provided that - disclaimer is in writing; - the transferor (or his legal representative) receives the written disclaimer no later than (1) nine months after the date of the transfer that created the interest the would-be beneficiary is disclaiming, or (2) if later, the day on which the would-be beneficiary turns 21; - the would-be beneficiary has not received the interest or any of its benefits; and - as a result of the disclaimer, the interest passes to a person other than the would-be beneficiary without any direction on the would-be beneficiary's part (Sec. 2518(b)).

In addition, certain transfers by would-be beneficiaries of property interests will be treated as qualified disclaimers (deemed disclaimers) if the transfers otherwise meet the requirements applicable to qualified disclaimers, i.e., any such transfer is in writing, it occurs within nine months after the date of the transfer that created the interest and the transferor did not accept the interest or any of its benefits (Sec. 2518(c)(3)). This exception operates to provide for deemed disclaimers for Federal tax purposes in situations that may not qualify under state law, for example.

For many years, the regulations under Sec. 2518 created two major roadblocks to disclaiming an interest in a joint tenancy. First, Regs. Sec. 25.2518-2(c)(4) provides that, generally, a disclaimer of an interest in a joint tenancy had to be made no later than nine months after the date the joint tenancy was created, rather than nine months after the death of the first joint tenant. Second, that same regulation section provided that a joint tenant could not disclaim any portion of the joint interest attributable to consideration provided by that tenant. Fortunately, the IRS last year liberalized its position in the wake of the Eighth Circuit's decision in McDonald, 853 F2d 1494 (8th Cir. 1988), on remand, TC Memo 1989440.

In McDonald, the Eighth Circuit held that the relevant transfer for determining whether a disclaimer is timely is the transfer of the survivorship interest on the first joint tenant's death, rather than the transfer that created the joint tenancy. The case was then remanded to the Tax Court, which held that a surviving joint tenant can disclaim property for which that joint tenant had provided the consideration. In AOD/CC-1990-06 (2/7/90), the IRS announced that it was acquiescing in the McDonald decision, so that if a joint tenant has the right under state law to sever the joint tenancy or have the property partitioned, it will no longer litigate that the relevant transfer is the transfer that created the joint tenancy. It also announced that it would no longer argue that a joint tenant cannot disclaim any portion of the joint interest attributable to consideration provided by that joint tenant.

Recent rulings confirm

new IRS position

Letter Ruling 9135043 involved a married couple that owned their Massachusetts home as equal joint tenants with right of survivorship. The husband had provided all the funds for the down payment, and had made all the mortgage payments on the home. His wife died in October 1990. The husband requested a ruling that he could make a deemed disclaimer of his wife's one-half interest in the home by transferring that interest to their daughter. (This proposed transaction was structured as a deemed disclaimer because, under Massachusetts law, a surviving joint tenant could not disclaim that portion of a joint tenancy interest allocable to amounts contributed by the survivor.) After the transfer, the husband and daughter would own the home as tenants in common, and the two planned to continue living in the home.

The Service ruled that if, within nine months of his wife's death, the husband delivered to the executor of his wife's estate a written deed of transfer for the one-half survivorship interest he received from his wife, the transfer would be treated as a qualified disclaimer. Further, the IRS stated that the husband's continued occupancy would not be considered an acceptance of the one-half undivided interest he was seeking to disclaim; his continued occupancy arose by virtue of his continuing ownership of his one-half undivided interest in the home, not by virtue of accepting the benefits of the disclaimed interest.

The Service noted that continued payments of 100% of the mortgage, taxes and other expenses of the property would result in gifts to the daughter equal to one-half of those payments. A question remained as to how such an arrangement would be treated if only one joint tenant, the person making the disclaimer, occupied the property after the disclaimer. Presumably, that joint tenant should pay rent to the nonresident tenant.

In another ruling, Letter Ruling 9135044, a married couple bought their home as tenants by the entirety in 1987. The wife died in October 1990. Her husband requested a ruling that he could make a qualified disclaimer of his wife's one-half interest by delivering a written disclaimer to the personal representatives of the wife's estate within nine months after her death. As a result of the disclaimer, the disclaimed interest would pass as a probate asset to the estate.

Under the wife's will, the interest would pass to a residuary trust (to the extent it would not give rise to Federal estate tax) or to a marital trust. The husband was the income beneficiary of both trusts. Further, the husband had the right each year to request the trustee of the residuary trust to pay him up to $5,000 or 5% of the trust principal, and the trustee could invade principal for the husband's health and education. At the husband's death, the principal was to be paid to their daughter. The husband also had the noncumulative right each year to withdraw 5% of the principal of the marital trust. Any principal remaining after the husband's death would be distributed to the residuary trust.

The IRS ruled that the husband's proposed disclaimer would be a qualified disclaimer. The ruling did not discuss any issues raised by the husband's status as income beneficiary of both the marital trust and the residuary trust; nor did it discuss the point that in many states, state law does not allow a spouse to partition property held in a tenancy by the entirety. However, in Letter Ruling 9208003, the IRS confirmed that the right to partition is crucial. A couple held property as tenants by the entirety in Arkansas. Under state law, neither tenant could sever the tenancy without consent of the other tenant. Therefore, the Service ruled that a valid disclaimer had to be made within nine months of the transfer that created the tenancy, rather than nine months after a tenant's death.

The fact that qualified disclaimers are now possible for joint tenancies with right of survivorship and some tenancies by the entirety is good news for clients who may otherwise find themselves taking unused unified credits to their graves.