The Beauty of Those Three Little Words: “No, Thank You”
October 1, 2004
Tamara "Tammy" Kolz- Boston
A disclaimer is a tool that can help meet the changing needs and
objectives of families.
Disclaimers have been in favor for centuries. Historically, the purpose of a
disclaimer was to prevent certain property from going to a beneficiary’s
creditors or to the tax collector. Those purposes still stand true today, but
the uses for disclaimers have expanded over time as sophisticated estate
planners have become more creative and forward-thinking. Given the significant
changes in the tax laws since the Economic Growth and Tax Rate Reconciliation
Act of 2001 (EGTRRA) and the uncertainty that exists as to the amount at which
the estate tax exemption will ultimately be set ($1,500,000 in 2004 but
increasing to $3,500,000 in 2009 and returning to $1,000,000 in 2011), the use
of disclaimers may be particularly appropriate in many estate plans today.
Definition
A disclaimer, in essence, is a refusal to accept a gratuitous transfer. It is
a renunciation of all or an undivided interest in property, whether the property
is to pass by gift, will, trust, retirement plan, insurance beneficiary
designation, or by state intestacy laws, which results in the property passing,
either outright or in trust, to the named alternate beneficiary.
Objectives
While a person may disclaim a gift received from a donor while the donor is
still living, disclaimers are more commonly used to alter the intended
distribution of the property after the death of the donor. Disclaimers offer an
estate planning opportunity at an optimal time: after the death of a person when
all of the facts and circumstances of the estate and the beneficiaries are
known. Accordingly, no crystal ball is necessary to guess the level of a
person’s assets or the financial well-being of potential beneficiaries. Often,
the purpose of a disclaimer is to avoid or reduce transfer taxes. There are
other non-tax reasons for using disclaimers as well, however, including but not
limited to, altruism toward the alternative beneficiary, accelerating a trust
termination, thwarting creditors of the disclaiming person, rewriting a will or
other disposition of assets, correcting a drafter’s error and avoiding an
environmental liability. Disclaimers may be used as an estate planning tool both
in hindsight as well as with foresight. To be sure, disclaimers need not only be
considered after one’s death; a good drafter will anticipate the use of a
disclaimer in crafting an estate plan.
Planning Strategy (How It Works)
While disclaimers are a valuable tool in the estate planner’s arsenal of
planning techniques, the cooperation of the intended beneficiaries is required
to achieve successful disclaimer planning. For this reason, the use of this tool
can be limited to harmonious families or at least to situations where there is a
financial payoff (e.g. a reduction in transfer taxes), which is generally
desired by all family members.
If a gift can be summed up by saying, “thank you; I’ll keep it,” a disclaimer
can be summed up by saying, “no, thank you; give it to the next person.” In
order for a gift to be effective, there must be something given by the donor and
accepted by the donee. If there is no acceptance by the donee, then there is no
gift. Conversely, for a disclaimer to be effective, there must be something
given by the donor and not accepted by the donee. Acceptance is generally
presumed, but if the gift is rejected by the donee within nine months from the
date of the intended transfer, and the donee has done nothing to indicate
acceptance in the interim, then the gift or transfer is not effective as to that
recipient and a disclaimer is possible. The nine-month deadline is inflexible,
however, and is unaffected by the donee’s lack of knowledge of the transferred
interest. Moreover, the clock begins ticking as to the nine-month deadline as of
the date of the transfer that creates the interest. Consequently, even if the
transfer is for the life of a beneficiary with succeeding interests to other
persons, a beneficiary who wishes to do so must disclaim his or her interest,
whether the interest is vested or contingent, within nine months of the original
transfer for the disclaimer to be effective. If the donee effectively
“disclaims” the bequest, then no gift or transfer is deemed to have been made to
or from the person making the disclaimer (the disclaimant). The disclaimed
property then passes to the alternate named beneficiary as if the disclaimant
had died prior to the transfer.
In order for a disclaimer to be effective for transfer and tax purposes all
of the following requirements must be met:
- the disclaimant’s refusal must be irrevocable and unqualified
- the disclaimer must be in writing
- the disclaimer must be delivered to the transferor of the interest, his
legal representative (e.g. executor or personal representative) or the holder
of the legal title to the property to which the interest relates
- delivery of the disclaimer must occur no later than nine months after the
date of the transfer creating the interest (e.g. will, trust, deed), or nine
months after the disclaimant attains the age of 21
- the disclaimant must not have accepted the interest or any of its benefits
prior to the disclaimer
- as a result of the disclaimer, the interest must pass, without any
direction on the part of the disclaimant, either to the spouse of the
transferor or to a person other than the disclaimant
If the disclaimer is effective, no transfer taxes will result from the
intended transfer or its renunciation. If effectively disclaimed, significant
tax benefits may result.
For example, assume a person (donor) dies and leaves a will, which leaves to
his son his entire interest in the family business and the remainder of his
estate to his wife. If the son does not survive him, his entire estate passes to
his wife. Assume also that as of the death of the donor, the value of the family
business has appreciated significantly and now greatly exceeds the estate tax
exemption and that the estate is insufficiently liquid to pay the estate taxes,
which will become due without selling assets and possibly the family business.
Donor’s son may disclaim an undivided interest in the family business within
nine months of the donor’s death, thereby permitting such interest to pass to
the wife as the alternate beneficiary. While the disclaimer may be motivated by
altruism on the part of the donor’s son to insure that the donor’s wife is
adequately provided for, it also serves the dual purposes of saving estate
taxes. The disclaimer permits the family business interest, which passes to the
donor’s wife, to escape estate taxation at the donor’s death as a result of the
availability of the unlimited marital deduction, which permits an unlimited
amount of assets to pass to a spouse tax-free.
In addition to increasing the marital deduction, other tax reasons exist as
to why a person may choose to disclaim his or her interest in certain property,
which reasons include, but are not limited to, saving the tax on the second
estate, increasing the charitable deduction, permitting the use of alternate
valuation, permitting special use valuation, preventing a generation-skipping
transfer (GST) taxable termination and taking advantage of GST grandfathering
provisions in pre-1976 instruments.
Tax Consequences
While the federal estate, gift and generation-skipping transfer tax laws
impose a tax on transfers, disclaimers are not transfers for purposes of
the tax laws. The disclaimed property is treated as if it had never been
transferred to the person making the qualified disclaimer and no transfer taxes
are imposed on the thwarted transfer to the disclaiming party.
Other Considerations
State law must be considered when using disclaimer planning. The law of the
state of both the donor and the donee may impact the effectiveness of a
disclaimer. Local conveyancing law, creditor protection laws and filing
requirements all may impact whether a disclaimant has made an effective
disclaimer. State law also may affect the ability to disclaim joint property
held by spouses or other persons, particularly if there is no right to partition
the property.
Conclusion
Clearly, there are many varied uses for disclaimers, not all of which are
driven by tax considerations. While the use of a disclaimer can provide a
wonderful planning opportunity, a disclaimer is only effective for its intended
purpose if provided in a timely manner and if the intended original recipient
does not accept any of the benefits of the disclaimed property. Accordingly, one
is well advised to remember the nine-month deadline and the fact that the clock
begins ticking at the date of the transfer creating the interest. Moreover, it
is essential that one consult with a local lawyer to ascertain the impact of
local laws on the use of disclaimers. Mindful of the requirements for an
effective disclaimer, a knowledgeable attorney with a creative mind can use a
disclaimer like a magical wand to meet the changing needs and objectives of
families.
For more information, e-mail Tamara Kolz at
tamara.kolz@hklaw.com or call toll
free, 1-888-688-8500.