Yin and Yang is an ancient Chinese concept of balance and continual change—the lofty goals of every estate planner. The easiest way to incorporate this concept is through the use of a disclaimer. Disclaimers can "Yin" by balancing unintended distributions created by survivorship designations, creditor problems, and scrivener’s errors and can "Yang" by changing the ultimate recipient in order to use tax exemptions, credits, and deductions.
As the details of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Pub. L. No. 107-16, unfold amid threats and cries for further changes, the use of disclaimers will increase dramatically to adjust dispositive instruments to subsequent legislative changes and effectuate the decedent’s intent when thwarted by the scrivener’s misunderstanding of the tax law. These uses are in addition to the standard retrofitting "opportunities" for disclaimers:
• appearance of unknown assets,
• execution by decedent of beneficiary designations inconsistent with the will or trust,
• change in the value of assets or circumstances of the beneficiaries, and
• qualification of gifts for the marital and charitable deductions.
This article highlights the use of qualified disclaimers by examining changes and developments since 1995.
When a person makes a qualified disclaimer of an interest in property, the interest is treated for transfer tax purposes as if it had never been transferred to the disclaimant. Code § 2518(a). Unlike the applicable credit amount and the annual gift exclusion, there is no dollar limitation on the value of the property disclaimed. The ability to disclaim is not dependent on the identity of the transferor of an interest or the type of property (as long as it is a severable interest) as is required for the marital deduction. In many states, the disclaimed property is protected from the claims of the disclaimant’s creditors.
But there are rules to qualify for this favored treatment. For disclaimers of interests created after December 31, 1976, Code § 2518 and Treas. Reg. § 25.2518 outline the requirements for a "qualified disclaimer" under the federal tax system. Code § 2518 was enacted to codify the common law and the fragmented statutory provisions of the Internal Revenue Code governing disclaimers before January 1, 1977.
Estate Tax Equivalent
Code § 2518 is applicable to the treatment of qualified disclaimers for federal gift tax purposes. The companion statute in Chapter 11 of the Code for treating qualified disclaimers under the federal estate tax rules is Code § 2046. Short and to the point, Code § 2046 reads: "For the provisions relating to the effect of a qualified disclaimer for purposes of this chapter, see section 2518."
Generation-Skipping Transfer Tax Equivalent
Code § 2654 addresses qualified disclaimers subject to the generation-skipping transfer tax. Not as short as Code § 2046, because it covers more than disclaimers, paragraph (c) of Code § 2654 repeats verbatim the language of Code § 2046.
The law relating to disclaimers before January 1, 1977, is summarized in Treas. Reg. § 25.2511–1(c)(2). Disclaimers of interests transferred before 1977 must be made in a reasonable time after the disclaimant has knowledge of the transfer and must be effective under local law.
Local law directs how the disclaimed property passes. This is important because disclaimed property must pass without direction by the disclaimant. If a disclaimer qualifies under Code § 2518 but is not effective under local law, the disclaimer is nevertheless treated as a qualified disclaimer if local law transfers the interest disclaimed without any direction from the disclaimant. Treas. Reg. § 25.2518–1(c)(1)(i). It is interesting to note that the reference to local law in Treas. Reg. § 25.2518–1(c)(1)(i) is applicable to "an interest created in a taxable transfer before 1982," and subparagraph (ii) for "interests created after 1981" is "reserved." Treas. Reg. § 25.2518–1(c)(1)(ii). As is so often the case, the lack of specific instruction from the IRS leaves the practitioner to rely on the rules of the previous era until new legislation is enacted. The cases for interests created after 1981 reflect the continued reliance on local law for determining whether the disclaimed property passes without direction of the disclaimant.
Code § 2518
A refusal to accept property will be a "qualified disclaimer" for taxation purposes if:
• the disclaimant makes an irrevocable and unqualified refusal in writing,
• that is received by the transferor, his legal representative, or the holder of the legal title of the property, not later than nine months after the later of (a) the day the transfer creating the interest is made or (b) the day the disclaimant turns 21,
• provided the disclaimant has not accepted the interest or any of its benefits, and
• the property passes, without any direction by the disclaimant, to either (a) the spouse of the decedent or (b) a person other than the disclaimant.
If these elements are met, the donee is treated as if the interest had never been transferred to him. Code § 2518(a); Treas. Reg. § 25.2518–1(b). If the qualified disclaimer is made by a decedent or the decedent’s executor, the value of the disclaimed interest will not be included in the decedent’s gross estate for federal estate tax purposes. Id.
The statute permits a disclaimer of an undivided portion of an interest. For purposes of Code § 2518, an interest in property includes a power with respect to property. Code § 2518(c)(1), (2).
Treas. Reg. § 25.2518—General
The regulations promulgated for Code § 2518 were not finalized until August 6, 1986. But the regulations did not respond to all of the issues that had arisen over disclaimers since Code § 2518 was added in 1977. Especially troublesome were the disclaimers of joint interests and the application of the rules to any "taxable transfer." The issuance of Action on Decision (AOD) 1990–06 (Feb. 7, 1991) attempted to clarify the joint interest position of the IRS, but in the process raised more and different concerns. Finally, amendments to the final regulations for Code § 2518 were issued, effective December 31, 1997. Specifically, the "new" regulations clarified:
• that Code § 2518 applies to any transfer and not just to "taxable transfers,"
• what constitutes a "transfer" for purposes of determining the starting point of the nine month period in which a disclaimer may be made, and
• the rules for disclaiming interests held in joint tenancy with right of survivorship or tenancies by the entirety.
Treas. Reg. § 25.2518–1(a)(3)
The introductory provision of Treas. Reg. § 25.2518 states the rules are applicable to transfers after December 31, 1976, but paragraphs (a)(1) of Section 1 are made applicable for transfers on or after December 31, 1997, by subparagraph (3) of Treas. Reg. § 25.2518–1(a).
Treas. Reg. § 25.2518–2(c)(3)(i)
The regulations before December 31, 1997 (referred to as the "Prior Regulations"), applied to any "taxable transfer." This phrase was a concept introduced in the legislative history of the Committee Reports, not the statute. The IRS used "taxable transfer," not "transfer," throughout the Prior Regulations, which caused confusion and raised questions as to the starting point of the time limit to make a qualified disclaimer. Changes to Treas. Reg. § 25.2518 effective for transfers on or after December 31, 1997 (referred to as the "Current Regulations"), clarify the applicability of Code § 2518 and the Current Regulations to any "transfers creating an interest," regardless of whether a tax was imposed.
Under the Current Regulations, a disclaimer must be made no later than nine months after the transfer creating the interest, or the day the disclaimant attains age 21. Treas. Reg. § 25.2518–2(c). For inter vivos transfers, the "transfer" occurs when there is a completed gift for federal gift tax purposes. For transfers by a decedent at death or that become irrevocable at decedent’s death, the "transfer" occurs on the date of death of the decedent. Treas. Reg. § 25.2518–2(c)(i).
Accordingly, in the following situations, the date of the transfer will be:
• foreign-situs property by nonresident alien decedent—date of decedent’s death;
• inter-vivos transfer included in decedent’s gross estate—date of gift;
• general power of appointment—date power created;
• interest passing by exercise, release, or lapse of general power—date of exercise, release, or lapse;
• nongeneral power of appointment (as to holder, permissible appointees and takers in default)—date power created;
• life estate and remainder interest, vested or contingent—date interest created; and
• disclaimed interest (successors of)—date interest was created in preceding disclaimant.
Treas. Reg. § 25.2518–2(c)(3)(i).
Not revised by the Current Regulations were the provisions of Treas. Reg. § 25.2518–2(c)(3)(i), sentences 11 and 13, relating to:
• remainder interest of QTIP—date creating the interest (opposed to date interest is subject to tax under Code § 2044 or 2519), and
• recipients of interests under age 21—date of 21st birthday.
Probably the most complex provisions of the Prior Regulations were the rules applicable to joint property that were dependent on whether : (1) the interests were unilaterally severable under local law, (2) the consideration was furnished by the disclaimant, and (3) the interest was included in the estate of the first to die. To simplify, the Current Regulations divide the rules into two categories:
Property Other Than Joint Bank, Brokerage, and Other Investment Accounts. Whether the interest is held in joint tenancy with right of survivorship or tenancy by the entirety, for property other than joint bank, brokerage, and other investment accounts, the following rules apply:
• disclaimer of the interest the joint owner acquires upon creation of the tenancy must be made no later than nine months from the date the tenancy was created,
• disclaimer of the survivorship interest must be made no later than nine months from the date of death of the first joint owner to die,
• the interest of the first joint owner to die is deemed to be one-half unless the following situation applies, and
• if the surviving joint owner is not a U.S. citizen and the interest was created on or after July 14, 1988, then the survivorship interest that may be disclaimed is any interest includible in the gross estate of the first joint owner to die.
Treas. Reg. § 25.2518–2(c)(4).
Joint Bank, Brokerage, and Other Investment Accounts. Qualified disclaimer of joint bank, brokerage, and other investment accounts are subject to the following rules:
• if the co-tenant can withdraw his contributions to the account without the consent of the other co-tenant, the survivorship interest may be disclaimed nine months from the date of death of the first co-tenant to die; and
• the surviving co-tenant may not disclaim any consideration furnished by the surviving co-tenant.
The co-tenants of these types of accounts do not have to be spouses. Treas. Reg. § 24.2418 B 2(c)(4)(iii).
Claims of Disclaimant’s Creditors
Neither the Code nor the Treasury Regulations specifically protect the disclaimed interest from the claims of the disclaimant’s creditors, but some protection may be afforded under local law. A disclaimer that is wholly void or is voided by the disclaimant’s creditors under local law is not a qualified disclaimer under Code § 2518. Treas. Reg. § 25.2518–2(c)(2). In Drye v. United States, the Supreme Court affirmed the decision of the U.S. Court of Appeals for the Eighth Circuit that a federal tax lien would not be thwarted by a disclaimer, and the interest could be attached. 528 U.S. 49 (1999).
Recent Rulings and Cases
The following are summaries of recent rulings by the IRS and court opinions relating to disclaimers.
Decedent’s will leaves everything to surviving spouse. If surviving spouse predeceases, the residuary passes to trust for son. Surviving spouse proposed to disclaim a percentage of the "Home Farm" using the following formula:
that percentage of the value of the "Home Farm" as finally determined for federal estate tax purposes such that the remaining undisclaimed percentage of the "Home Farm" and the other undisclaimed assets passing to the Spouse by virtue of Decedent’s death will be sufficient to result in the lowest federal estate tax being imposed upon the estate after allowing for the unified credit and other allowable credits.
The IRS ruled that the disclaimer described by the formula would be a qualified disclaimer. PLR 9646010.
Date of Transfer for Joint Tenancy
Decedent’s will leaves residue to surviving spouse. If surviving spouse predeceases, the residue passes to decedent’s children. The couple acquired their residence as joint tenants in 1965. Under local law, surviving spouse had the right to unilaterally sever the tenancy.
The surviving spouse will disclaim within nine months of decedent’s death the one-half interest in the residence that would otherwise pass to surviving spouse by right of survivorship or under the residuary clause of the will.
The IRS ruled that the survivorship interest was created on the decedent’s date of death, so surviving spouse’s disclaimer qualifies. PLR 9733008.
The decedent and the surviving spouse owned a brokerage account held as JTWROS. After the decedent’s death, but before qualifying as executor, the surviving spouse withdrew the income from the joint brokerage account and authorized transfer of the joint brokerage account to a new account in his name only. After qualifying as executor, the surviving spouse transferred one-half of the income from the joint brokerage account to an estate account and one-half of each security in the joint brokerage account to a brokerage account for the estate.
The surviving spouse disclaimed the survivorship interest in the joint brokerage account, causing decedent’s interest to pass to the residuary trust under the will, of which the surviving spouse is a beneficiary.
The IRS reasoned that authorizing the transfer of the joint brokerage account was not acceptance because the surviving spouse did not draw on the account or otherwise assert control. In addition, the withdrawal of the income from the joint brokerage account was not acceptance because none of the funds were used. Further, there was no deemed acceptance by the surviving spouse because of local law vesting title immediately at the decedent’s death. The disclaimer qualifies. PLR 199932042.
Transfer Before 1977 and Exempt GST Trust
Grandmother died testate before 1977, creating a trust for mom that gave mom a power of appointment. Mom exercised the power in favor of a trust created under mom’s will, of which daughter is a beneficiary.
Daughter decides to disclaim a fraction of the property transferred to said trust. (The date daughter learned of the transfer, the effective date of the disclaimer, and the date the disclaimer was delivered to the trustee are not specified in the ruling.)
Referring to Treas. Reg. § 25.2511–1(c)(2) and Jewett v. Commissioner, 455 U.S. 305 (1982), the IRS ruled that daughter’s disclaimer was effective because it was made within a reasonable time after she had knowledge of the transfer.
Grandmother’s trust was grandfathered under the GST rules because it was irrevocable on September 25, 1985. The exercise of the power by mom did not cause the trust to be subject to the GST tax. PLR 199945010.
Pecuniary Amount by Formula and GST
By her will, grandmother gave specific shares of stock and proceeds of a bank fund to a trust for the benefit of grandson. The residuary estate passed to daughter.
Grandson disclaimed so much of the trust property, valued as of grandmother’s death, that was in excess of grandmother’s available GST exemption, together with the income and increase attributable to the property. The disclaimer was delivered to the executor within nine months of grandmother’s death, and no interest in the trust was accepted by the grandson before the disclaimer. The disclaimed property passed to the residuary estate for the benefit of daughter.
The IRS ruled that the grandson’s disclaimer qualified as a disclaimer of a severable interest. The disclaimed amount passed to daughter (a nonskip person), so the disclaimed interest is not subject to GST tax. Grandson’s trust has an inclusion ratio of zero for purposes of the GST tax. PLR 200001045.
Qualified Plan and QTIP Trust
Decedent named surviving spouse the primary beneficiary of his 401(k) plan and the trustee of the QTIP trust created under decedent’s management trust as the contingent beneficiary. The trustee of the QTIP trust is required to pay the net income of the trust, and all the income portion of any installment from any plan, to the surviving spouse. The surviving spouse has a testamentary special power of appointment over the trust.
Surviving spouse proposes to disclaim her interest as the primary beneficiary of the 401(k) plan, and the power of appointment. The trustee will segregate the assets of the plan from the other assets in the QTIP trust. Surviving spouse will not serve as trustee of the QTIP trust.
Although local law allows disclaimers up to 12 months from the transfer, surviving spouse will disclaim within the time limitation of Code § 2518. The IRS concluded that the disclaimers qualify, and the 401(k) plan qualifies for the marital deduction. PLR 200105058.
Expectation Is Not Consideration
Surviving spouse was disturbed when he found out that the 29 specific cash bequests made by his wife under her will would be significantly reduced by death taxes and in some cases GST tax. Determined to reduce the burden, surviving spouse talked to the beneficiaries about executing disclaimers. All 29 disclaimed. In December 1989 and January 1990, surviving spouse made gifts to each of the disclaimants in approximately the same amount as the bequest under his wife’s will. The IRS disallowed the marital deduction claimed on the wife’s estate tax return in the amount of the disclaimers, and charged the estate with GST tax, determining the disclaimers were invalid.
Ruling in favor of the IRS, the Tax Court found an implicit agreement between the surviving spouse and the beneficiaries, which was consideration for the disclaimers, and thus the disclaimers failed to meet the requirements under Code § 2518.
Reversing the Tax Court in part and remanding for further determination, the U.S. Court of Appeals for the Fifth Circuit found that the fact that surviving spouse made gifts after the disclaimants renounced their bequests was not consideration that disqualified the disclaimers. "A mere expectation of a future benefit in return for executing a disclaimer will not render it ‘unqualified.’" Estate of Monroe v. Commissioner, 124 F.3d 699 (5th Cir. 1997).
Surviving spouse disclaimed part of the interest in stock given to her under husband’s will. As a result, the surviving spouse had a minority interest in the stock. The court concluded that the marital deduction would be based on the value of the shares to which the surviving spouse was entitled after the disclaimer. Estate of DiSanto v. Commissioner, 78 T.C.M. (CCH) 1220 (1999).
Son died intestate and under state law certain interests passed to son’s father. Father disclaimed and the interest passed to son’s wife, qualifying for the marital deduction. The IRS asserted consideration was given by the wife in exchange for the disclaimer.
The court found the disclaimer was qualified and awarded attorney fees and costs to the wife. Estate of Lute by Lane v. United States, 19 F. Supp. 2d 1047 (D. Neb. 1998).
Retrofitting for Marital Deduction
Decedent died with a 1970 will that was sorely out of date with the decedent’s assets, family situation, and tax laws. The executor used disclaimers to qualify the gift to the residuary trust for the marital deduction. The court held the trust qualified. Estate of Lassiter v. Commissioner , 80 T.C.M. (CCH) 541 (2000).
Taxpayer asserts that his handwritten, unsigned schedule of assets and the probate inventory are qualified disclaimers. The attorney for taxpayer drafted a disclaimer, but it remained unsigned and apparently unread by the taxpayer. Taxpayer argues his intent was clear and that the doctrine of substantial compliance should be applied.
The court found that the statute requires "an irrevocable and unqualified refusal, expressed in writing, to accept an interest in property." Such "a design avoids arguments about undisclosed intentions and unexpressed election of choices." The court affirmed the Tax Court’s decision that taxpayer failed to make a qualified disclaimer. Chamberlin v. Commissioner, No. 00-70291, 2001 U.S. App. LEXIS 10911 (9th Cir. 2001).
A disclaimer is a powerful tool in the estate planner’s hands. It is available whether specifically included in the document or not. Following the concept of Yin and Yang, the technique can produce harmony, peace, love, and a little mischief in the decedent’s estate.
Kristi N. Elsom is a member of Fizer, Beck, Webster, Bentley & Scroggins, P.C., in Houston, Texas.