Qualified Disclaimers and Post-Mortem Planning
Overview: One of the most common estate planning strategies for married individuals is for each spouse to leave his or her entire estate to their surviving spouse. Due to the unlimited marital deduction, an entire estate (regardless of size) can pass to the surviving spouse without incurring any federal estate taxes upon the first death. However, such a strategy fails to take advantage of the applicable exclusion amount of $2,000,000 (in 2008) that each individual can transfer to heirs completely free of gift or estate taxes, potentially subjecting the survivor's estate to higher than necessary future taxes. This undesirable situation occurs because all property remaining in the survivor's estate will otherwise be subject to estate taxation.
One popular trust arrangement designed to address this issue in advance is the common "A/B" combination, typically set up as a revocable trust that can be modified at any time prior to death. However, there is another option, known as a qualified disclaimer, that can provide some flexibility after a spouse has died. How much do you know about qualified disclaimers?
Test your knowledge with this short quiz!
- True or False. This planning technique may be useful in situations where property arrangements were not established prior to death.
- Which of the following is not a requirement for a disclaimer to qualify for federal tax purposes:
A. The disclaimer must be in writing and must be irrevocable;
B. The disclaimed interest must pass according to the direction of the person disclaiming the property;
C. With the exception of a spouse, the person disclaiming the property cannot receive any benefit from the disclaimed property, such as trust income; or
D. None of the above.
- True or False. Any decision to disclaim an inheritance should be reviewed carefully to determine if such a decision is consistent with the overall goals and objectives of the disclaimant.
Read here to learn more about qualified disclaimers.
This post-mortem planning technique may be useful in situations where "A/B" trusts or similar arrangements were not established prior to death. Rather than transfer all property to the surviving spouse using the unlimited marital deduction, thereby wasting the first spouse's applicable exclusion amount, the surviving spouse can disclaim a portion of his or her inherited property. The disclaimed property then passes to other heirs or beneficiaries as if the surviving spouse had predeceased. The estate can then take advantage of the applicable exclusion amount with respect to the disclaimed property.
In order to be effective for federal tax purposes, a disclaimer must meet the following requirements:
- The disclaimer must be in writing and must be irrevocable;
- The disclaimed interest must pass without direction by the person disclaiming the property.Consequently, before deciding to disclaim, it is advisable to know who, under the will or applicable state laws, will receive the property instead. Typically, a will can direct the disposition of any disclaimed property;
- The written refusal must be received by the grantor of the interest (or the grantor's estate) within nine months of the taxable transfer creating the interest (or, where the disclaimant is a minor, within nine months of the disclaimant's 21st birthday); and
- With the exception of a spouse, the person disclaiming the property cannot receive any benefit from the disclaimed property, such as trust income.
Spouse's Special Exemption
If the surviving spouse wants to take advantage of this strategy, yet desires a lifetime income from the disclaimed property, a provision in the decedent's will could accomplish this feat by establishing a disclaimer trust. With this alternative, the surviving spouse can effectively establish an "A/B" trust after the death of the first spouse.
Disclaiming an inheritance might prove useful in certain situations. For example, suppose your wealthy uncle, a widower without children, has named you as the beneficiary of his entire estate, but has also stipulated that should you die before him, his estate will be distributed to your children. Sadly, your uncle passes away unexpectedly, and at a time when you are financially comfortable and really don't need the money. Accepting your inheritance will just increase the value of your estate, and, hence, your potential tax bill, when it ultimately passes to your children. A better alternative might be to benefit your children today by disclaiming the inheritance, with no associated gift tax imposed as a result of the transfer—assuming all qualified disclaimer requirements are satisfied.
Proceed with Caution
Be aware that there are instances, such as in smaller-sized estates for which a surviving spouse's standard of living will be dependent upon all of his or her assets, where a qualified disclaimer may not be an appropriate choice. In addition, if the property in question is of substantial value, and is transferred to an individual two or more generations younger than the donor, a disclaimer could trigger generation-skipping transfer taxes (generally levied on property transfers valued above $2,000,000 per individual in 2008, scheduled to increase to $3,500,000 in 2009 and become unlimited in 2010).
Nevertheless, under the appropriate circumstances, a qualified disclaimer may be an effective tool to assist in reducing the effects of transfer taxes. Remember, however, that any decision to disclaim an inheritance should be reviewed carefully, in advance, with a qualified legal professional to determine if such a decision is consistent with your overall goals and objectives.
Quiz Answers: 1) True; 2) b; 3) True.