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Chapter 11: Disclaimers.

WHAT IS IT?

A disclaimer (or renunciation) is an unqualified refusal by a potential beneficiary to accept benefits given through a testamentary or lifetime transfer of property. Most often, a disclaimer refers to the refusal by a potential beneficiary to accept a bequest under the terms of a will or trust.

For federal tax purposes, the disclaimant (i.e., the potential beneficiary who refuses to accept the transfer of property) is regarded as never having received the property. The disclaimant is treated for federal tax purposes as if he predeceased the transferor of the property. As a result, no transfer is considered to have been made by the disclaimant for federal gift, estate, or generation-skipping transfer (GST) tax purposes. (1)

A disclaimer may be effective for federal tax purposes, even if the disclaimer is not effective under local law. However, to be fully effective for both state and federal purposes, the disclaimer must comply with federal and applicable state law, and may have to meet separate rules to be effective for state tax purposes.

WHEN IS THE USE OF SUCH A DEVICE INDICATED?

1. When an individual with children and a large estate in his own right is left a bequest by another individual and this bequest would compound the recipient's potential estate tax problem, a disclaimer may be an appropriate estate planning tool. The first recipient may wish to disclaim the bequest in favor of the next recipients under the will or trust, very often his children. By making the disclaimer, the disclaimed property will not be included in the disclaimant's estate at his death.

2. Where an individual who is in a high income tax bracket is left a bequest "if he is living, otherwise to his children," and his children are in lower income tax brackets, a disclaimer can shift the income taxation attributable to the property to the children's lower tax brackets (assuming the children are age 18 or older) if the children are the next recipients of the bequest under the will or trust.

3. Where a beneficiary of property under a will or trust wishes to make a tax free gift to the person who would be the next recipient of such property under the will or trust, he can disclaim the property.

4. When property is left to a surviving spouse who doesn't need or want it, the surviving spouse could disclaim the portion he doesn't want and avoid a needless double taxation upon his death.

5. As a corollary to the last situation, where the value of the property left to the surviving spouse creates a marital deduction which reduces the deceased spouse's taxable estate below the amount offset by the deceased spouse's estate tax unified credit exemption equivalent, a disclaimer by the surviving spouse can be used to increase the deceased spouse's estate to an amount which will be fully offset by the unified credit equivalent, and keep the property out of the estate of the surviving spouse for estate tax purposes. Refer to the extended discussion in Chapter 24.

6. Where the bequest to the surviving spouse is not sufficient to take advantage of the optimum marital deduction, a disclaimer by other beneficiaries in favor of the surviving spouse may be used to qualify a transfer for the marital deduction. This planning option takes on even greater importance because of the increasing unified credit exemption equivalents created by the Economic Growth and Tax Relief Act of 2001. Refer to the discussion of marital deduction planning in Chapter 24.

7. Where there is a trust with an interest passing to charity that does not meet the requirements for a charitable deduction discussed in Chapter 33, a disclaimer by other beneficiaries may be used to qualify the trust interest for the deduction.

8. Where an error was made in the drafting of a will or trust, a disclaimer may be used to correct the error, if the circumstances permit.

9. Where there is a need or desire to avoid creditors, it may be appropriate to use a disclaimer. The desire to avoid creditors most often arises in the case of an elderly or disabled beneficiary whose receipt of assets would disqualify such beneficiary from receiving certain benefits (e.g., SSI or other medical benefits). However, a disclaimer for the purpose of avoiding creditors may not be permitted by state or federal law. State and federal law should be consulted prior to making a disclaimer for the purposes of avoiding creditors.

WHAT ARE THE REQUIREMENTS? (2)

1. There must be an irrevocable and unqualified refusal to accept an interest in property.

2. The refusal must be in writing.

3. The writing must be received by the transferor, his legal representative, or the holder of legal title to the property.

4. The refusal must be received no later than nine months after the later of (a) the date on which the transfer creating the interest in the disclaimant is made, or (b) the day on which the disclaimant attains the age of 21.

5. The disclaimer must be made prior to the disclaimant's acceptance of the interest or any of its benefits. A beneficiary and his counsel should exercise extreme caution in their approach to an inheritance, as seemingly inconsequential, and often unintended, actions can constitute "acceptance" of the interest, thereby precluding an effective disclaimer.

6. The interest must pass either to the spouse of the decedent or to a person other than the disclaimant without any direction on the part of the disclaimant. (A valid disclaimer by a surviving spouse may be made even though the interest passes to a trust in which the surviving spouse has an income interest.)

7. The interest disclaimed should be an entire interest, but can be an undivided fractional part of the proposed gift. Since it is often difficult to identify within nine months the exact amount of an inheritance, the amount of a disclaimer can be calculated pursuant to the terms of a formula.

HOW IT IS DONE--EXAMPLES

1. Doug Koch, a wealthy client, has four children. Doug's aunt just died and, under the terms of her will, Doug was named as the sole beneficiary of her entire estate if he is alive. If he is deceased when she dies, Doug's four children are named equally as contingent heirs. Doug has adequate assets and income to live comfortably, and does not need additional property to compound his already high potential estate tax. By filing in writing an effective qualified disclaimer within nine months of his aunt's death, Doug will be deemed to have predeceased his aunt for federal transfer tax purposes and his interest in her estate will be distributed to his children under the terms of her will without any federal gift, estate, or GST tax liability to him.

However, if Doug had consulted his estate planner before taking action, the planner might have brought about Doug's reconsideration of his proposed disclaimer by an explanation along these lines: If Doug makes a qualified disclaimer, then for federal transfer tax purposes, his interest in his aunt's estate will be treated as if the interest had never been distributed to him. The property otherwise distributable to Doug will be distributed to his children pursuant to the terms of his aunt's will. The distribution of the property to Doug's children will constitute a direct skip for GST tax purposes. The transfer(s) may or may not attract the GST tax, depending upon how much property is involved and on the extent to which the aunt's GST tax exemption ($2,000,000 in 2006) is allocated to the transfers. If Doug's aunt has used her unified credit and is in the highest estate tax bracket (46% in 2006), the estate tax and the GST tax combined could virtually wipe out the property otherwise going to Doug's children.

2. Ed Radosh specifically leaves $100,000 to his son with a gift over to his favorite charity if his son disclaims. After Ed's death, his son can decide whether to accept the bequest and donate it to charity, and receive an income tax deduction on his personal income tax return, or to disclaim the property in favor of the charity and have his estate receive the charitable deduction.

3. Jules Einhorn thought that, at his death, his wife would have ample funds and his son very little. Therefore, he left most of his property to his son, with a contingent gift to his wife in the event his son predeceased him. At the time of Jule's death, the son was financially well off, but the surviving spouse was in more difficult financial straits. By disclaiming his share and permitting the surviving spouse to take, the son not only allowed a better distribution of assets, but also may have qualified Mr. Einhorn's estate for a marital deduction due to the transfer of the assets to the surviving spouse. This could result in a substantial saving on federal estate taxes. The surviving spouse could then make gift tax-free transfers to her son using the gift tax annual exclusion and the unified credit.

4. The combined estates of Mr. and Mrs. Smith are worth approximately $1,500,000. They each intend to leave their share of the estate to the other, or if both are deceased, in trust for their minor children. Since the total value of their estates is less than the unified credit exemption equivalent ($2,000,000 in 2006), there is no estate tax consequence. However, the estate has a substantial growth potential.

The Smiths should consider the use of a disclaimer trust. This is a trust that will function only in the event the surviving spouse (or his or her estate representative) disclaims the bequest under the will or trust. The trust may be for the benefit of the surviving spouse and the children, or the children only. If, at the death of the first spouse, the combined estates of the deceased and surviving spouses would exceed the unified credit exemption equivalent ($2,000,000 in 2006), then the surviving spouse can disclaim into the trust to take advantage of all or part of the unified credit exemption equivalent of the estate of the deceased spouse. When the surviving spouse dies, the trust created by the disclaimer will bypass his or her taxable estate.

WHAT ARE THE TAX IMPLICATIONS?

1. A disclaimer of a property interest or a power is not treated as a gift by the disclaimant for gift tax purposes. (3)

2. A disclaimed interest in property is not considered to be a transfer by a disclaimant for estate tax purposes and will not be included in his estate at death.

3. If property is disclaimed by a person in favor of a surviving spouse or charity, the marital or charitable deduction will be permitted, provided the property would otherwise qualify for these deductions. (4)

4. Generally, any income attributable to disclaimed property will be chargeable to the person in whose favor the property was disclaimed (i.e., the owner of the property).

IMPLICATIONS AND ISSUES IN COMMUNITY PROPERTY STATES

Please refer to the background information on Community Property contained in Chapter 7. A qualified disclaimer is taken into account for purposes of the marital deduction. In either a separate property or a community property state, a disclaimer can be expected initially to qualify the estate for the marital deduction or to increase or decrease the deduction if the surviving spouse gains or loses because of the disclaimer.

The availability of the unlimited marital deduction, which applies to both separate and community property, alleviates concerns for future planning in this area. However, different rules apply to the disposition of separate and community property by will in community property states and therefore it is still important to carefully characterize all of the property interests held by a decedent and his or her spouse to determine if under community property rules a disclaimer is desired or required.

Where the entire community property is subjected to probate (both the decedent's one-half interest and the surviving spouse's one-half interest) upon the death of only one spouse, the surviving spouse should exercise caution to disclaim only the community property interest of the decedent. A disclaimer of both halves would probably result in a taxable gift to the individual who takes as the result of the disclaimers. As mentioned in Chapter 7, several types of problems can arise when attempting to determine whether specific property is to be characterized as community, quasi-community, or separate.

QUESTIONS AND ANSWERS

Question--Can a beneficiary of a life insurance policy disclaim his interest in the proceeds?

Answer--Yes, such an interest may be disclaimed within nine months of the insured's death. However, if the beneficiary was an irrevocable beneficiary, the disclaimer most likely must be made within nine months of the beneficiary designation.

Question--Can an interest in jointly held property be disclaimed?

Answer--Yes, if made within nine months of the creation of the gift and before any of the property or its benefits have been accepted by the disclaimant. However, with respect to a disclaimer of joint property that passes by right of survivorship, the nine month period generally starts with the date of death of the first joint tenant regardless of whether either tenant could have partitioned the property under state law while both tenants were living. (5)

Question--Can an individual after attaining age 21 disclaim property if he has received an interest in the property during his minority?

Answer--The law indicates that an individual can make a qualified disclaimer after attaining age 21, if the disclaimer is made within nine months after reaching age 21 and if the other requirements of the law are met. However, the law does not allow a qualified disclaimer if benefits have been received from the property prior to the disclaimer.

A beneficiary who is under 21 years of age has until nine months after his 21st birthday in which to make a qualified disclaimer of his interest in property. Any actions taken with regard to an interest in property by a beneficiary or a custodian prior to the beneficiary's 21st birthday will not be an acceptance by the beneficiary of the interest. For example, a minor who receives dividends on stock prior to the age of 21 will not be deemed to have made an acceptance, assuming he did not accept dividends after attaining age 21. This rule holds even with respect to a gift under the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act where under either Act custodianship ends and the property is delivered to the donee when he attains age 18. (6)

Question--If a testator dies leaving a trust with income payable to his wife for her lifetime and remainder payable to his child, can the child disclaim the child's remainder interest after the wife's death?

Answer--Not unless the wife died within nine months of the testator; the disclaimer must be made within nine months of the testator's death since this is when the gift was complete. The child would have to disclaim within this period or, if later, within nine months of the date the child reaches age 21. Note that the answer here is the same even if the child must survive the wife to receive the bequest.

Question--Is a disclaimer valid where a surviving spouse refuses to accept all or a portion of an interest in property passing from a decedent, and, as a result of that refusal, the property passes to a trust in which that spouse has an income interest [such as the typical family (nonmarital "B") trust]?

Answer--A disclaimer will be valid where a spouse refuses an interest in property even if, as a result of that disclaimer, he or she receives an income interest (as long as that income interest does not result from the surviving spouse's direction). However, the spouse must not have the power after the disclaimer, as trustee or otherwise, to direct the distribution of the trust assets to other beneficiaries.

This "Blank Check" postmortem marital deduction planning tool means an estate owner doesn't have to decide how much of his estate should go to a surviving spouse by will. His will can allow that decision to be made by the survivor when more facts are known. All the estate owner's property could be left to the surviving spouse with a provision that any part of the bequest that is disclaimed will be placed in the nonmarital ("bypass") trust. This planning may-in some cases--be preferable to a specific marital formula bequest.

Question--What are some of the other things one considers about the use of a disclaimer?

Answer--Some of the factors to be considered are:

1. If a disclaiming beneficiary is indebted to the estate, the instrument should specify whether the debt may be set off against the alternative takers (who might be the disclaimant's children). (7)

2. A disclaimer of a power may extinguish it; hence, it may be desirable to designate an alternative donee of the power. (8)

3. A disclaimer of a legacy may result in the disclaimed legacy passing to the disclaimant's issue under an anti-lapse statute. (9)

4. A disclaimer could cause a premature "closing" of a class of beneficiaries. (10)

5. It is generally desirable to express a partial disclaimer in the form of a fraction or percentage. A partial disclaimer may be valid only if it represents an "undivided portion of an interest." (11) However, the disclaimer regulations do permit a beneficiary to disclaim specific assets in a trust, if as a result of that disclaimer, the assets in question will be allocated to another trust or to beneficiaries other than the trust.

6. To guard against the possibility that the disclaimed property may not pass to someone other than the disclaimant (unless it is to a surviving spouse), an alternative taker should be provided for. Further, the statutory schedule may not coincide with the settlor's intent.

7. The instrument should indicate whether a disclaimer accelerates future interests. (12)

Question--What is the effect of a disclaimer, if federal requirements are met, but state disclaimer laws are not?

Answer--State law is important because it governs property rights, and how and under what conditions and to whom property will pass. It is possible that a person could make a valid disclaimer under federal law which would not be an effective disclaimer of property rights under state law (e.g., a disclaimer which is made within the nine-month period prescribed by federal law, but not within the shorter time period prescribed by state law). Federal law makes provision for disclaimers that fail under state law. A written transfer that otherwise meets the requirements of a qualified disclaimer for federal tax purposes will be treated as a qualified disclaimer, if the disclaimed property passes to a person or persons who would have received the property had the disclaimant made a qualified disclaimer. (13)

Question--What is the problem, if any, in disclaiming life insurance proceeds?

Answer--If a life insurance policy names a spouse but no secondary beneficiary, a disclaimer could result in the policy proceeds falling into the estate of the insured. This would expose the proceeds to creditors, additional probate fees, will provisions, and, in many states, unnecessary estate or inheritance taxes. If the disclaiming spouse is the beneficiary under the will, a further renunciation would be necessary, because the insurance proceeds would fall into the probate estate as a result of the first disclaimer. Planners should examine beneficiary designations and coordinate life insurance (or pension plan) proceeds so that a single renunciation will accomplish the intended objectives.

Question--Is it possible to disclaim some of, but not all of, a beneficiary's interest in a trust?

Answer--Generally, a trust beneficiary may not disclaim an interest in some trust assets and not others. The trust assets are not severable. (14) However, a trust beneficiary may disclaim his interest in trust principal and retain his interest in trust income, since an income interest and principal interest are deemed to be separate interests. In addition, since disclaimers of an undivided portion of any separate interest in property are permitted, it is possible for a trust beneficiary to disclaim a percentage or fraction of the beneficiary's interest in the trust (e.g., 10% of the beneficiary's income interest).

Question--Assume the surviving spouse is entitled to survivor's benefits under a qualified pension or profit sharing plan. Can he disclaim all of, or any part of, those benefits?

Answer--The IRS has recently ruled that such disclaimers are effective. This planning device can be extremely important in view of the requirements that such plans provide survivor annuities (discussed in Chapter 52). Where the retirement plan benefit is most of the value in the estate, the mandatory payment to a surviving spouse may deprive the decedent's estate of the full value of the unified credit. A disclaimer can be used to shift at least part of the benefit away from the surviving spouse to take full advantage of the decedent's credit, and keep that part of the benefit out of the estate of the surviving spouse.

Question--Can the trustee of a trust disclaim powers held as a trustee, such as the power to make distributions to the trustee as a beneficiary?

Answer--Although the cases and rulings are not entirely clear on this issue, and a trustee may be able to make a qualified disclaimer, the cautious answer is that a qualified disclaimer should be made only by the beneficiary or donee, not the trustee. For example, if the trustee has the power to make distributions to himself or herself and wants to avoid the tax consequences of such a power, the trustee should disclaim the right to receive the distributions, not the right to make them. The trustee would then be disclaiming as a beneficiary, not as a trustee.

ASRS: Sec. 54, [paragraph]44.3(m); Sec. 55, [paragraph]57.5(f).

CHAPTER ENDNOTES

(1.) IRC Sec. 2518(a). However, it is possible for a disclaimer to create a generation-skipping transfer (GST) by someone other than the disclaimant. This result can occur because, under GST tax law, a "direct skip" transfer (i.e., a transfer to or for an individual two or more generations younger than the transferor) is a GST subject to the GST tax (if it is also subject to federal estate or gift tax). IRC Secs. 2612(c), 2613(a). The first example under HOW IT IS DONE-EXAMPLES illustrates how a disclaimer can create such a GST.

(2.) IRC Sec. 2518(b).

(3.) IRC Sec. 2518(a).

(4.) IRC Secs. 2056(d)(2), 2055(a).

(5.) Treas. Reg. [section]25.2518-2(c)(4).

(6.) Treas. Regs. [section][section]25.2518-2(d)(3), 25.2518-2(d)(4), Example (11).

(7.) Matter of Colacci, 549 P.2d 1096 (Colo. App. 1976).

(8.) Schwartz, "Effective Use of Disclaimers," 19 B.C. Law Rev. 551 (1978).

(9.) Brannan v. Ely, 157 Md. 100, 145 Atl. 361 (1929); Thompson v. Thornton, 197 Mass. 273, 83 N.E. 880 (1908).

(10.) See Schwartz, Future Interests & Estate Planning, [section]11.4 (Supp. 1978).

(11.) Schwartz "Effective Use of Disclaimers," 19 B.C. Law Rev. 551, 567, 573 (1978).

(12.) Schwartz Future Interests & Estate Planning, [section][section]11.5-11.9 (Supp. 1978).

(13.) IRC Section 2518(c)(3).

(14.) However, disclaimers of specific trust assets are permitted, if the assets are thereby removed from the trust and pass, without any direction by the disclaimant, to persons other than the disclaimant or the spouse of the decedent. Treas. Reg. [section]25.2518-3(a)(2).
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Title Annotation:Part 2: Ownership and Transfer of Property
Publication:Tools & Techniques of Estate Planning, 14th ed.
Date:Jan 1, 2006
Words:3936
Previous Article:Chapter 10: Power of appointment.
Next Article:Chapter 12: Selection of executor, trustee, and attorney.
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