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.