Donald M. Thompson - Wills, Trusts, and Estate Planning



A disclaimer is a refusal to accept an interest in property. A qualified disclaimer is a disclaimer that complies with the requirements set forth in the Internal Revenue Code. When a person who is supposed to receive an interest in property disclaims it the result is usually that someone else gets the property.

The same result as to disposition of the interest could be achieved if the person who is to receive the interest just accepted it and then made a gift of the interest to the person or persons who would get it if a disclaimer was made. The consequences of using this procedure could be much different from using a disclaimer because of the tax laws. First, giving the interest away after it has been accepted is a gift subject to the gift tax. If a large amount is involved a gift tax return must be filed and either the tax must be paid or part of the donor's credit must be used. Second, the person to whom the interest is supposed to pass may be in a category which creates adverse tax consequences. For instance a taxable estate may be willed to a child, or if the child is not alive to XYZ Church. The parent then dies and the child, who has left everything by will to the grandchildren, dies soon thereafter. There are 2 taxable estates here. A disclaimer by the child's executor would result in the first decedent's (the parent's) estate passing to the XYZ Church and bypassing the child's estate. XYZ Church may qualify for the charitable deduction. Note that the church rather than the grandchildren gets the property and for this reason the disclaimer may not be made. If the child's will gives everything to the XYZ Church, instead of the grandchildren, then a disclaimer by the child's estate would make perfect sense and avoid estate tax.

The fact that the donee is in an undesirable status for tax purposes is a very common reason to use disclaimers. For instance in the above example a parent wills property to a child, but if the child does not survive to XYZ Church. Instead of this assume the parent's will provides that if the named child does not survive the property shall pass to the named child's children (grandchildren) and if they do not survive to the brothers and sisters of the named child. The parent dies and the named child dies soon thereafter. To avoid having 2 taxable estates the child's executor or administrator could disclaim, but then the named child's children, who are grandchildren, would take and this may generate generation skipping tax. To avoid this the grandchildren could disclaim as well and the property would then pass to the other children of the grandparent. Note once again that the grandchildren may not have an incentive to do this.

There are many reasons for using disclaimers besides the examples given above. They can change an estate plan after death and are very often used to repair defects in the plan. For instance property may be given to a person in trust with the income to be paid to that person (the beneficiary) along with principal as he demands it. After the beneficiary's death the trust provides that other persons get the property. The right to withdraw principal is a general power of appointment which means the property is in the beneficiary's estate for tax purposes when he or she dies. A life interest without the power to withdraw principal would not ordinarily be in the beneficiary's estate. For this reason the right to withdraw principal, the power of appointment, might be disclaimed.

Disclaimers are also often used to defer decisions in estate planning until after death when the situation may be more clear. For instance conventional estate tax reduction planning for the smaller taxable estate utilizes 2 trusts - one for the marital deduction and one for the tax free amount. Theoretically one trust is for the surviving spouse and one is for the children, although the surviving spouse can get the income from both. This works very well if the decedent has $4,000,000 cash in his or her own name and the tax free amount is $2,000,000. $2,000,000 goes to each trust. The $2,000, 000 for the kids' trust is tax free. The other $2,000,000 passing to the marital trust qualifies for the marital deduction. When the surviving spouse dies later the $2,000,000 marital trust is in his or her taxable estate. Since it does not exceed the tax free amount, there is no tax. The $2,000,000 in the kids' trust is not subject to tax when the surviving spouse dies because it is not in the taxable estate of the surviving spouse who had only a life interest in income. The result is that even though the tax free amount is $2,000,000, a married couple can pass $4,000,000 tax free to their kids. The key is for each to give $2,000,000 to the kids.

If the decedent has $4,000,000 in an IRA instead of his or her own name the situation is different. Any distribution from the IRA will usually be subject to income tax. The way to defer this as long as possible is to give the IRA to the surviving spouse who can roll it over to his or her IRA. The entire transfer will qualify for the marital deduction and be free of estate tax. This means there is no gift to the kids' trust and the entire $4,000,000 is subject to estate tax when the surviving spouse dies (ignoring other factors which might result in reduction of the $4,000,000 while the surviving spouse is alive.)

There are 2 competing considerations here. One is deferral of income tax, which requires the wife individually to be beneficiary of the IRA, and one is the reduction of the estate tax which requires the kids' trust to get part of the IRA. The decision as to what to do with the IRA will be easier to make after the holder of the IRA dies. At that time the facts will be clearer as to life expectancies, tax rates and other laws, and the relative needs of the beneficiaries will be clearer. Deferring the decision can be done by naming the spouse as beneficiary of the IRA and the children's trust as contingent beneficiary. The surviving spouse can then take the IRA or disclaim part or all of it. The part disclaimed would go to the trust.

If there is a qualified disclaimer of an interest in property under the Internal Revenue Code the Code applies as if the interest had never been transferred to the disclaiming person. To be qualified a disclaimer must be in writing and delivered to the transferor of the interest or the holder of legal title within 9 months of the later of the day on which the transfer creating the interest is made or the day on which the disclaiming person reaches 21. The disclaimer must be irrevocable and unqualified and the disclaiming person cannot have accepted the interest or any of its benefits. The person making the disclaimer cannot designate who will take the interest and it must pass either to the spouse of the decedent or to a person other than the person making the disclaimer. Under federal law a transfer by the person who would otherwise disclaim to the person who would receive the interest as a result of the disclaimer can also qualify.

The Federal law only governs the Federal tax effects of disclaimer. State law governs whether there is any disclaimer to begin with. Under Illinois law, unless specified to the contrary in the instrument transferring the property or creating the interest, disclaimed property descends or is distributed as if the disclaimant had died before the decedent or before the date on which the transfer is made or the interest is created or before the takers are determined.

An entire interest in property can be disclaimed or only part of it. Undivided portions of an interest may be disclaimed. The disclaimer of a partial interest can specify a fraction of the interest (such as half) or a specific monetary amount (such as $100,000.)

Disclaimers can be made by persons specified to take an interest and by trustees, executors, administrators, guardians and agents under powers of attorney. All except the person directly named are fiduciaries. They act for someone else and have legally enforceable duties to act only for the persons for whom they act. This means they can disclaim only if it is in their beneficiary's best interests. Also, in many cases they could disclaim only if the trust, will or power of attorney appointing them gives them specific authority to do so or if they have court approval.

These requirements very often make disclaimers by trustees difficult because they are supposed to get property for the trust's beneficiaries, not disclaim it. The same applies to other fiduciaries. The beneficiaries could approve the disclaimer, but some trust beneficiaries are often not ascertainable until the future so beneficiary approval is impossible to get. For this reason a trustee who has power to disclaim may not want to do so.

|| Back to List of Topics ||
See My Probate Web Site ||
See My Business Law Web Site || See My Securities Arbitration Web Site ||

Donald M. Thompson * 55 W. Monroe #3950; Chicago, IL 60603
Ph: 312-782-0844 * Fax: 312-201-1436 * Email: