Welcome to Luca!globe
CPA Journal - May 1998 Current Issue!    Navigation Tips!
Main Menu
CPA Journal
Professional Libary
Professional Forums
Member Services



Frank G. Colella, LLM, CPA

One of the most significant post-mortem planning techniques available to estate practitioners is the disclaimer. Disclaimers can increase the post-mortem options available to the estate. For example, disclaimers can increase the value of the marital deduction (disclaimers in favor of the surviving spouse), reduce the value of an overfunded marital bequest (disclaimers by the surviving spouse), or redirect the passage of an interest (disclaimers in favor of children). The United States Court of Appeals for the Fifth Circuit, in Estate of Monroe v. Commissioner ("Monroe II") [No. 95-60576, __ F.3d __ (5th Cir. 1997), rvsg 104 T.C. 352 (1995)], restored a significant degree of this post-mortem planning flexibility when it reversed the Tax Court ("Monroe I") [104 T.C. 352 (1995)] and held that the taxpayers and their advisors can intelligently discuss and implement a post-mortem estate plan utilizing disclaimers.

Statutory Requirements

IRC section 2518 governs disclaimers for Federal tax purposes. The disclaimer must be an irrevocable and unqualified refusal to accept an interest. A qualified disclaimer made pursuant to IRC section 2518 has the effect of treating the disclaimed interest as if it had never been transferred to the disclaimant. No gift or estate tax consequences will, therefore, be attributed to the disclaimant.

Four statutory requirements must be met to have a "qualified disclaimer:"

    1. The disclaimer must be in writing and identify the property or interest disclaimed;

    2. The written disclaimer must be received by the transferor of such interest within nine months of the later of (a) the date of transfer creating the interest, or (b) the day in which the disclaimant attains the age of 21;

    3. The disclaimant must not have accepted the interest, or benefited there from; and

    4. The interest must pass without any direction from the disclaimant to the surviving spouse of the decedent or to a person other that the disclaimant.

Factual Background

Louise Monroe died on April 28, 1989. She was a resident of Louisiana and was survived by her husband, Edgar. The couple had no children or descendants. The decedent's will directed that three testamentary trusts be established for her grandnieces and grandnephew. In addition, there were specific cash bequests to 31 individual and 4 corporate beneficiaries. Taxes attributable to these bequests would be apportioned to the legatees. The remainder of the decedent's estate passed to her husband. The will also provided that any disclaimed or lapsed bequests would pass to Mr. Monroe.

Mr. Monroe and his nephew served as executors. They retained the services of an accounting firm to advise them on tax and post-mortem planning issues. The accountants advised Mr. Monroe and his nephew that significant estate (and generation skipping transfer) taxes could be saved by employing disclaimers to increase the amount qualifying for the marital deduction. The accountants identified 29 legatees who would be asked to renounce their interests in favor of Mr. Monroe. In addition, the accountants prepared and rehearsed, with the executors, the script that would be used in requesting the disclaimers.

Mr. Monroe personally asked five of the legatees to disclaim, and the remaining legatees were asked by his nephew. Each legatee who was asked to disclaim did, in fact, sign a written renunciation that would constitute a valid disclaimer under Louisiana law. These documents were executed during December 1989. The total value of the disclaimed interests was $892,781. The disclaimed amount was included in the marital deduction claimed on the decedent's estate tax return. Between late December 1989 and January 1990, Mr. Monroe sent the disclaimants personal checks bearing the notation "gifts," in amounts equal to or exceeding the amounts that they had earlier disclaimed.

The commissioner disallowed the marital deduction in an amount equal to the 29 disclaimed bequests. The petitioners contended that the requirements for valid disclaimers had been met and the estate was entitled to the marital deduction for the disclaimed bequests that passed to Mr. Monroe. Specifically, argued the petitioners, the disclaimers and subsequent gifts to the disclaimants by Mr. Monroe were separate and unrelated transactions because there were no agreements or promises between any legatee and Mr. Monroe (or the nephew) "to exchange a disclaimer for consideration."

Monroe I

The Tax Court agreed with the commissioner that the disclaimers were not "irrevocable and unqualified" because the legatees accepted "consideration" for making the disclaimers when they accepted the cash gifts from Mr. Monroe shortly after disclaiming their bequests. The court held that, "A disclaimer is not 'irrevocable' if a legatee or heir formally disclaims but, in substance, receives his or her bequest. A disclaimer is not 'unqualified' if a legatee or heir is induced or coerced into disclaiming his or her bequest as happened in this case."

The Tax Court specifically rejected the petitioners' contention that, for the purpose of IRC section 2518(b)(3), "consideration" be given its traditional meaning--that an explicit promise or agreement must exist between the parties at the time of the disclaimer. The court noted, "The consideration for the disclaimers was the implied promise that they would be better off if they did what Monroe wanted them to do than if they refused to do so." Finally, the court was unpersuaded that Mr. Monroe's gifts were part of a lifetime pattern of generosity: "The inference drawn from the targeted gift-giving is that Monroe made them 'in return' for the disclaimants renouncing their bequests and not from a 'detached and disinterested generosity.'"

Interestingly, the Tax Court did not conduct an individual analysis of each of the 29 disclaimers. There was no finding that a particular disclaimer was induced because of a promise of future consideration or, conversely, was coerced from the disclaimant. Instead, the court found that 28 of the 29 disclaimers were unqualified because of an "implicit agreement" between the parties which rose to a level of consideration sufficient to render all of them unqualified. Only one disclaimer was found by the Tax Court to have been made "voluntarily and without expectation of anything in return."

Monroe II

The Majority Opinion. In a decision written by Judge Edith Jones, with which Judge Duhe concurred, the Fifth Circuit held that the Tax Court's view that "implied promises" constituted consideration was "inconsistent with a holistic reading of IRC section 2518(b), contrary to the governing Treasury Regulations and the service's letter rulings, and intolerably, unnecessarily vague." Judge Jones focused specifically on the question of whether the disclaimants had, in fact, received any consideration in exchange for making the disclaimers. She answered this question in the negative and specifically held that a "mere expectation" or even an "implied promise" does not constitute consideration. The correct analysis was whether the "decision to disclaim was part of mutually bargained for consideration or a mere unenforceable hope of future benefit, whether that hope springs from family ties, long-term friendship or employment, or a generalized fear that benefits will be withheld in the future absent the disclaimer."

Accordingly, the "disclaimant's mere expectation of a future benefit in return for executing a disclaimer will not render it 'unqualified.'" To support this holding, Judge Jones cited private letter rulings in which the IRS specifically acknowledged that the parties would receive some future benefit from executing the disclaimers. In private letter ruling 9509003 (March 3, 1995), for example, the IRS stated "We conclude that although the five disclaimants have acted in concert in making disclaimers in order to reduce the estate tax liability of the decedent's estate, such action does not constitute the acceptance of any consideration in return for making the disclaimer within the meaning of section 25.2518-2(d)(1)" (emphasis added).

As if to highlight the shortcomings of the Tax Court's analysis, the majority also found that each individual disclaimer required individual analysis. In reviewing each disclaimer, the court found that the evidence adduced as to the majority of them supported the finding that no consideration had been given in exchange for the disclaimer. In the case of one, in which Airline Animal Hospital disclaimed $5,000, the only evidence was the written disclaimer itself and the court found no reason to doubt that it was executed "voluntarily and without consideration." Only as to six specific individuals did the court remand the issue to the Tax Court for additional fact finding and analysis in accordance with the proper standard of review.

The Dissenting Opinion. Judge King dissented from the majority view and would have affirmed the Tax Court's holding. He believed that the majority's standard, "mutually bargained for consideration," was too exacting for the IRS to meet. In his words, "only the naive or the uncounseled will engage in actual bargaining for consideration to be received in exchange for a disclaimer or, as is the case with the six disclaimants that are the subject of the majority's remand, will admit to it." However, Judge King did not present an alternative framework for consideration. Other than an argument that the majority may have imposed a more rigid consideration requirement than is found in contract formation, Judge King would simply have adopted the Tax Court's analysis.

Analysis. Both Monroe decisions are significant because they point out the potential pitfalls and opportunities in the post-mortem planning area. Monroe I was an especially troubling decision because the holding ignored the petitioners' statutory compliance with section 2518(b) and introduced a subjective determination of "intent" to disallow the disclaimers. Monroe II reversed that unfortunate outcome and calls for careful review of the post-mortem planning in the context of the overall estate because the IRS may still seek to examine the "intent" behind the disclaimers.

In other words, Monroe II is binding precedent only in states that can seek judicial review of a Tax Court decision in the Fifth Circuit. In addition, the IRS may still petition the Supreme Court to review Monroe II. However, whether or not Monroe II is actually reviewed by the Supreme Court, the IRS is likely to litigate its position in other circuit courts. Therefore, using disclaimers in post-mortem estate plans may generate close scrutiny by the IRS.

The outcome of Monroe I means that planning continues to be a case-by-case analysis of the facts and circumstances giving rise to the use of a disclaimer. This continues to be the case outside of the Fifth Circuit's jurisdiction, despite a significant taxpayer victory in Monroe II. The Tax Court and IRS may continue to look beyond the written documentation of the disclaimer and seek to determine whether the disclaimers were in some cases "coerced" from the disclaimants or whether the disclaimants, regardless of motive, expected to be compensated for making the disclaimers.

The Tax Court's position that a disclaimant's mere expectations can prevent a bona fide disclaimer seems to require an analysis of the facts and circumstances surrounding each and every disclaimer--something the court in Monroe I did not actually undertake. While a "disclaimer-by-disclaimer" examination may not be intended by such a position, that consequence is clearly foreseeable.

Of the two points made in Monroe I, the issue of coercion is straightforward. If, in fact, the renunciations were "coerced" from the disclaimant, the disclaimers would not be qualified. For example, the court observed "testimony of many of the disclaimants suggests that they feared what would [have] happened if they refused to renounce their bequests." However, whether the disclaimants were coerced and, thus, the disclaimers are not voluntary is a separate and distinct issue from whether the disclaimant expected to receive compensation. In the latter instance, the disclaimer would be unqualified because the disclaimant bargained for consideration. Still, the Tax Court did not undertake an examination of each disclaimer to determine its individual qualification, or lack thereof.

However, the finding in Monroe I that the disclaimants expected something in return and thus received "consideration" is troublesome because, inevitably, most disclaimants expect some benefit as a result of their disclaimers. Most, if not all, disclaimers are, in fact, motivated in some degree by tax considerations. The Fifth Circuit observed, "How likely is it, in tax terms, that people would disclaim 'a bird in the hand' purely altruistically?" For example, a child disclaiming an interest to increase an estate tax marital deduction may also "anticipate" or hope for a benefit from the disclaimer from the surviving parent during his lifetime or through an inheritance. That was the factual background in private letter ruling 9509003 and that subjective belief of the disclaimants did not negate a finding that the disclaimers were "qualified."

Ultimately, to subscribe to the Tax Court's view that expectations and implied promises constitute consideration renders every instance of disclaiming an interest a purely factual question that must be resolved on a case-by-case basis. Would the result in Monroe I have been the same if Mr. Monroe had had a long-established prior history of making annual gifts to the disclaimants? Were the gifts, made shortly after the disclaimers, part of Mr. Monroe's annual routine, evidenced by prior gifts made to the same disclaimants? Or, would the result have changed if, absent a prior history of gifts, Mr. Monroe waited three, six, or perhaps twelve months, before making the "gifts" to the disclaimants? How much time would have to pass between the disclaimers and the subsequent gifts to nullify the claim that the gifts were made "in exchange for" the disclaimers?

While the above questions are legitimate ones, given the premise of the Tax Court's analysis, even more difficult, however, is determining precisely which particular issues motivated the court to reach its conclusion. Did the efforts of the accountants to identify the interests that could be disclaimed and the subsequent development of a plan to obtain the disclaimers create an atmosphere of "involuntariness"? This is the very role we would expect an estate planner to adopt. Now, as a result of the lasting effects of Monroe I, will practitioners advising clients to secure disclaimers from estate beneficiaries become less aggressive in providing that counsel?

On the other hand, perhaps the result in Monroe had less to do with the role of the accountants advising the executors on the beneficial role of disclaimers than it did with the closeness in time that the disclaimants in turn received the gifts that implied there was "consideration." It appears from the record that the subsequent gifts were made without the knowledge of the accountants. Perhaps the timing of the subsequent gifts was the critical factor. It seems unlikely that, if Mr. Monroe had been involved in an annual gifting program to the disclaimants, the result would have been the same. The isolated nature of the gifts he made to the disclaimants, taken together with the other factors (especially the implied "coercion"), supported the court's finding that the disclaimants expected the gifts as the quid pro quo for disclaiming their interests in favor of Mr. Monroe.

Don't Give Up the Fight

Despite the taxpayer victory in Monroe II, it is still difficult to gauge the future impact of Monroe I, which would seem to continue to give pause to an aggressive use of disclaimers. Attention should be given to the taxpayer's prior history of annual gifts. Once again, however, it may be the unique circumstances of Monroe that led to the initial result.

Better practice, however, suggests avoiding the circumstances of Estate of Monroe altogether. If the taxpayer has had no previous history of making "gifts" to the intended disclaimants, gift giving should be postponed for as long as possible to avoid any connection between the disclaimers and the "gifts"--and to avoid the finding that the "gifts" are the consideration for the disclaimers. Fundamentally, however, the significant planning opportunities available through the use of disclaimers should continue to be pursued aggressively. *

Eric M. Kramer, JD, CPA
Farrell, Fritz, Caemmerer, Cleary, Barnosky & Armentano, P.C.

Laurence Foster, CPA
KPMG Peat Marwick LLP

Contributing Editors:
Richard H. Sonet, CPA
Marks Shron & Company LLP

Frank G. Colella, LLM, CPA
Own Account

Jerome Landau, JD, CPA

James B. McEvoy, CPA
Chase Manhattan Bank

Nathan H. Szerlip, CPA
Edward Isaacs & Company LLP

Lenore J. Jones, CPA
Jacobs Evall & Blumenfield LLP

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

©2009 The New York State Society of CPAs. Legal Notices

Visit the new cpajournal.com.