Looking a Gift Horse in the Mouth: Qualified Disclaimer can be a Powerful Estate Planning Tool

Estate Planner May-June 2007

At first glance, turning down an inheritance may seem like a foolish move. But in many cases, doing just that may be the best strategy. You (or your heirs) can use a qualified disclaimer to redirect property to another person while reducing the tax burden on your family.

What’s a disclaimer?

A disclaimer is an irrevocable and unqualified refusal to accept an interest in property. When you make a disclaimer, the disclaimed property is treated as if it had never been transferred to you. The property then passes – according to the terms of the transferor’s will or trust – as if you had died before him or her.

If your disclaimer is “qualified” (see “What qualifies a disclaimer?” below), you can redirect the property to a family member or other recipient without negative gift or estate tax consequences.

A qualified disclaimer is a flexible estate planning tool with a variety of uses. Here are a few examples:

” Marie’s will leaves all of her property to her three daughters or, in the event a daughter predeceases her, to that daughter’s children. When Marie dies, one of her daughters, Julie, is terminally ill. If Julie disclaims her inheritance, the property automatically passes to her children without being included in her taxable estate. Depending on how much is being disclaimed by Julie, Marie’s estate may be subject to generation-skipping transfer (GST) tax.

” Same facts as the first example, except that when Marie dies all of her daughters are healthy. One of the daughters, Jill, however, is quite successful and has already built up a substantial estate. Rather than expose her inheritance to unnecessary estate taxes, Jill makes a qualified disclaimer and allows the property to pass directly to her children. Similarly, there may be GST tax consequences to Marie’s estate by virtue of Jill’s disclaimer.

” Jim dies in 2007, leaving a $4 million estate. Jim’s will leaves everything to his wife, Lori, or, if Lori doesn’t survive him, to their children. The problem with Jim’s estate plan is that it wastes his $2 million federal estate tax exemption. The assets he leaves to Lori are sheltered from federal estate tax by the unlimited marital deduction. Lori dies in 2008, when the estate tax exemption remains at $2 million and the top marginal estate tax rate is 45%. Assuming the assets she inherited from Jim represent her entire estate and they are still worth $4 million, her estate will owe $900,000 in estate tax on those assets – or more if subject to state estate taxes.

If, instead, on Jim’s death Lori makes a qualified disclaimer with respect to half of Jim’s assets, or $2 million, that amount will pass directly to their children federal-estate-tax free, making full use of Jim’s $2 million exemption. When Lori dies, the remaining $2 million is sheltered from estate tax by her exemption, and no federal estate tax will be due at her death. Her estate tax liability will be reduced by at least $900,000.

Plan your estate with disclaimers in mind

Be sure to consult your estate planning advisor before making any disclaimers. You shouldn’t make a disclaimer unless you’re confident that it will achieve your objectives and that you understand the tax consequences. Remember that you can’t control the disposition of disclaimed assets. If you make a disclaimer, the assets will pass automatically according to the terms of the transferor’s estate plan.

Likewise, in planning your own estate, you can provide your family with the flexibility to make the most of your legacy by carefully spelling out who will receive disclaimed property.

Sidebar: What qualifies a disclaimer?

Under Internal Revenue Code Section 2518, a disclaimer of an interest in property is qualified if it meets these requirements:

1. The disclaimer is in writing.

2. The disclaimer is delivered to the transferor, or his or her representative, within nine months after the transfer is made (or, if later, within nine months after the disclaimant turns 21).

3. The disclaimant hasn’t accepted the disclaimed property interest or any of its benefits.

4. As a result of the disclaimer, the property interest passes – without any direction from the disclaimant – to the transferor’s spouse or to someone other than the disclaimant.