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Beneficiaries can be the key to making an estate plan work.

Qualified Disclaimers Can Add
Flexibility to an Estate Plan

By Paul J. Streer and Caroline D. Strobel

In many cases, optimum tax strategies are not determinable until after a taxpayer's death. Use of qualified disclaimers enable beneficiaries to take advantage of these strategies and still carry out the taxpayer's wishes. The authors explain how they work to minimize estate, gift, and generation-skipping transfer taxes.

In light of the ever changing financial and personal circumstances, those engaged in financial planning have long recognized the need to build flexibility into the estate planning process. For example, the optimum-sized marital deduction needed to minimize transfer taxes and still meet other planning objectives is often best determined at the taxpayer's death. That is the only time when wealth accumulations of the decedent and other family members are known with any degree of certainty. Until then, the planner and his clients must rely on speculative estimates of future asset values in formulating their estate plans. In addition, estate liquidity and family support needs are uncertain until the actual date of death.

Fortunately, qualified disclaimers can prove to be an excellent vehicle to provide needed flexibility in estate planning. They can even be effectively used as a postmortem planning device where the estate plan has not satisfactorily incorporated unanticipated changes in circumstances since the plan was last reviewed and implemented. To obtain optimum benefit from qualified disclaimers, however, their post-death use should be anticipated. The will and related trust documents should be drawn with the probable use of disclaimers in mind.

What is a Qualified Disclaimer?

For purposes of Federal estate, gift and generation-skipping transfer taxes, a disclaimer is an irrevocable and unqualified refusal by a person to accept an interest in property. Properly disclaimed property will be treated as though it had never been transferred to the person making the disclaimer if the following requirements are met:

* The refusal is in writing;

* The written refusal is received by the transferor, his legal representative, or the holder of the legal title not more than nine months after the later of a) the date on which the transfer creating the interest in such person is made or b) the date on which that person reaches age 21;

* The person has not accepted the interest or any of its benefits; and

* The property must pass to someone other than the person making the

In addition, the property must pass without any direction on the part of the disclaimant.

A special rule provides that if a surviving spouse is the disclaimant, the spouse can make a valid disclaimer even though the disclaimed property passes for the spouse's benefit if it does so without any direction on the spouse's part. To qualify, the form of the benefit must either be that of a life estate for the spouse or that of an income interest in a trust. Some estate plans include a disclaimer trust as part of the overall plan to specifically utilize this provision as part of the postmortem planning process. This assures that disclaimed property passes to a beneficiary determined by the decedent. If the surviving spouse is the trustee of the disclaimer trust, the spouse can have discretionary powers as trustee to benefit themselves and others provided the powers are limited by an ascertainable standard. The surviving spouse can also be an income beneficiary and receive distributions of principle made at the discretion of an independent third party trustee.

Failure to adhere to each of the above requirements will cause the disclaimant to be considered the recipient of the decedent's property. The disclaimant will then be deemed to have gifted the disclaimed property to its ultimate recipient. A taxable gift can trigger the imposition of a gift tax and may substantially increase the disclaimant's transfer tax base. If the ultimate recipient is two generations below that of the transferor, the generation-skipping transfer tax may also be imposed.

Meeting the Requirements

The First Two Requirements. Meeting the first two requirements incorporating a timely filed written refusal into the process is usually easily accomplished. Normally, explicit directions contained in the will, plus proper communication and follow-up on the part of the practitioner, will insure compliance.

No Acceptance. On the other hand, determining whether the requirement that property or its benefits are not accepted by the disclaimant has proven to be controversial in many instances. The IRS found that a widow had not made a qualifying disclaimer where all of her expenses were paid by the estate between the date of her husband's death and the date she filed a disclaimer. Although she eventually repaid the total amount expended on her behalf, she received a significant economic benefit from the interest free use of the estate's funds between the date of death and date of the disclaimer, (IRS Letter Ruling 8405003).

Recently, the Tax Court Estate of Louise S. Monroe v Commissioner, 104 T.C. No. 16 (March 27, 1995)] determined that the renunciation of cash legacies, followed by cash payments to the disclaimants by the surviving spouse, were not qualified disclaimers. Acting upon the advice of his accountant, the surviving spouse approached the 29 different legatees involved about disclaiming their cash bequests to reduce the total transfer tax liability by increasing the size of the estate tax marital deduction. In at least one instance, he promised to "take care of" the legatee if he renounced his bequest. In all other cases, the legatees merely had reason to believe they would get the money back from him at a later date. The Court found the legatees had accepted consideration for their disclaimers in the form of an implied promise they would be better off if they honored the surviving spouse's request. In all but one of the 29 cases, it determined the disclaimer made was not "qualified" because the heir or legatee in question was induced or coerced into making the disclaimer. This decision and its liberal interpretation of "inducement" should act as a warning signal whenever taxable gifts are made to disclaimants.

The above example can be contrasted with the situation where children and grandchildren disclaimed their interests in an estate to qualify more property for the marital deduction and thus reduce estate taxes. There was no expressed or implied agreement between the disclaimants and the widow regarding any expectancy of inheriting an enhanced estate. The IRS felt that future inheritance was "purely speculative," thus the disclaimers were held valid, (IRS letter ruling 9509003).

A valid disclaimer can be made where a beneficiary manages property that is part of an inheritance. The IRS found that a surviving spouse's management of estate property in a fiduciary capacity prior to disclaiming her interest in the property does not constitute acceptance of benefits (IRS letter ruling 9513011). As one of several personal representatives, the surviving spouse was involved in selecting directors for a corporation that was a general partner of a limited partnership included in the decedent's gross estate. The partnership interest was the subject of the disclaimer.

Redirection. The requirement that the disclaimant not redirect the distribution of the disclaimed property to another person requires the person responsible for drafting the will to designate who will receive the disclaimed property. Failure to do so means that any disclaimed property will pass under one of the various state law provisions. The likelihood that, in a given situation, property dispositions left to state law will perfectly mesh with the decedent's desire for the passage of property at death is remote at best. Consequently, in some cases, disclaimers will not be utilized and transfer taxes will be overpaid. Alternatively, to produce some tax savings, qualified disclaimers may be made even though the applicable state laws provide for property dispositions that are less than optimum when non-tax factors are considered. This emphasizes the need to provide for a disclaimer trust by will so property will pass in an optimum manner and the maximum amount of flexibility is maintained for post-mortem planning purposes.

Partial Disclaimers

A disclaimer of only a portion of property that would otherwise pass to a beneficiary or donee is also treated as a qualified disclaimer if all statutory requirements are met. However, so-called partial disclaimers of property will only be respected if 1) the portion disclaimed is severable from the part accepted and 2) the specific assets disclaimed are identified in the disclaimer itself. The ability to accept some transferred property, while disclaiming the remainder, is the underlying key to optimizing the transfer tax savings that can accrue from qualified disclaimers.

Disclaimers of Jointly Owned

A word of caution is in order when the property to be disclaimed is the surviving joint tenant's interest in jointly held property. A qualified disclaimer can only be made by the transferee or donee of property. Consequently, if the surviving spouse is considered to be the original
transferor because he or she used their own funds to purchase the jointly held property, a qualified disclaimer cannot be made with respect to the property. As part of the planning process, all jointly held property should be evaluated to determine whether or not it can be disclaimed by the surviving joint tenant.

The disclaimer of a joint bank account or jointly held mutual fund shares will qualify if properly made. This is so because a gift of a survivorship interest is not complete until the death of the first joint tenant unless a withdrawal of funds is made. Conversely, a disclaimer of a survivorship interest in a tenancy by the entirety filed after death will not be qualified under applicable state law because the survivor is treated as acquiring the survivorship interest at the time the property was acquired and placed in the tenancy by the entirety, rather than at the death of the first tenant, (IRS Letter Ruling 9427003).

Use of Disclaimers to Optimize the Marital Deduction

A disclaimer used to optimize the marital deduction can be illustrated as

Dick died in January, 1995. He was survived by Joanne, his wife, and Stephanie, his adult daughter. Dick's will provided that all of his property would pass to Joanne. If Joanne disclaims her interest in any property, it passes to a trust with income payable to Joanne for her life, remainder to Stephanie. Assume lifetime gifts have been limited to $10,000 per person, per year. Consequently, no adjusted taxable gifts will increase Dick's transfer tax base.

In this situation, the entire estate will qualify for the marital deduction. Dick's unified credit has not been utilized. Property in the estate will be fully taxable on Joanne's death subject to any remaining unified credit available to Joanne's estate. A partial disclaimer by Joanne of property valued at $600,000 would ensure the utilization of Dick's unified credit. Income from the disclaimed property would still be available for Joanne's use. Corpus in the trust may appreciate over Joanne's remaining life and pass to Stephanie free of any transfer tax consequences upon Joanne's death. Furthermore, a provision could have been provided in the will that would have allowed limited distributions of corpus from the trust to Joanne at the discretion of an independent trustee. This provision would insure that if some unforseen need arose prior to Joanne's death, the resources of the trust would be available for her use.

Another situation that could present itself can be illustrated by varying the earlier fact pattern.

If, at the time of Dick's death, because of her age or physical condition, Joanne is also expected to die soon, it may be wise for Joanne to disclaim enough of the marital transfer to equalize the size of the two estates. This approach will reduce the amount of estate tax paid overall because of the higher marginal transfer tax rates that would otherwise apply to a portion of her taxable estate. Even though estate tax may need to be paid by Dick's estate, Stephanie will end up with a larger aftertax inheritance.

Now assume the following change in the original fact pattern:

Dick's will provides that all of his property shall pass to Stephanie and if Stephanie disclaims her interest in any property, it passes to a trust with income payable to Joanne for her life and remainder to Stephanie's son, George.

Under this scenario, Dick's unified credit will be fully utilized. However, no use will be made of the marital deduction. As a result, the imposition of the estate tax liability will not be deferred. Furthermore, no use will be made of the $l million generation-skipping transfer tax exemption available to Dick. However, if Stephanie disclaims all or a portion of the property that is to pass to her under the terms of the will, the executor can qualify that value of trust property for the QTIP marital deduction by making a timely election. In addition, a so-called "reverse QTIP" election can be made by the executor that utilizes Dick's $1 million generation-skipping transfer tax exemption. If this is done, all or a portion of the trust property will be transferred to George free of any generation-skipping transfer tax when Joanne dies and the trust terminates. The date of death fair market value of the trust property that qualifies for the QTIP marital deduction in Dick's estate will be includible in Joanne's gross estate.

Qualifying a QTIP Trust

In circumstances where a trust provides for multiple income beneficiaries including the surviving spouse, the trust may still be able to qualify for the marital deduction through the use of qualified disclaimers. Property disclaimed by income beneficiaries other than the surviving spouse will qualify for the marital deduction under the "qualified terminal interest" or QTIP provisions. A disclaimer by multiple income beneficiaries may also be necessary if property used to fund a trust with multiple income beneficiaries consists of S corporation stock. Multiple income beneficiaries will preclude the trust from qualifying as a Qualified Subchapter S Trust.

A qualified disclaimer might also prove useful where property is transferred to a marital deduction trust that gives the surviving spouse a general power of appointment. A disclaimer of the general power of appointment by the surviving spouse could qualify the trust for the QTIP election. This could be beneficial if the decedent's generation-skipping transfer tax exemption had not been fully utilized, since it would permit a reverse QTIP election to be made with respect to $1 million of trust property. The qualified disclaimer of a general power of appointment may also prove useful because the QTIP trust property may be removed from attachment by the surviving spouse's creditors.

Avoiding the Generation-Skipping Transfer Tax

Disclaimers can allow property to flow through to grandchildren or great grandchildren, thus bypassing intermediate generations and avoiding multiple transfer taxes. To the extent these transfers qualify for the generation-skipping transfer tax exemption, transfer taxes for the family unit will have been minimized. The opposite case also may call for the use of a disclaimer. Where property in excess of the generation-skipping transfer tax exemption has been left to a skip generation person, the use of a disclaimer by the younger generation beneficiary or his representative can avoid the imposition of the generation-skipping transfer tax. *

Paul J. Streer, PhD, CPA, is professor of accounting at the J.M. Tull School of Accounting, University of Georgia.
Caroline D. Strobel, PhD, CPA, is professor of accounting at the University of South Carolina.

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