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ESTATE AND TAX PLANNING FALL 1998 REPORT JUST SAYING "NO": DISCLAIMERS IN ESTATE PLANNING & ADMINISTRATION This article is the adapted text of a recent presentation by three members of the Firm's Trust, Estates and Private Clients practice group, James W. Reid, David E. Stutzman and Carolyn M. Glynn. This article was edited by Mr. Stutzman for publication in the Spring 1999 Newsletter of the New York State Bar Association Trusts and Estates Law Section (Vol. 32, No. 1). THE NATURE AND PSYCHOLOGY OF DISCLAIMERS Mr. Reid: We are talking today about disclaimers in estate planning and administration. This is a compelling subject because disclaimers represent such a simple but often overlooked way to make a powerful impact on the transfer of family wealth. 5 Reasons to Highly Regard Disclaimers As attorneys, we spend a great deal of time working with our private clients to plan for the disposition of their assets in effective, emotionally-satisfying and tax-efficient ways. This effort frequently involves the use of some rather fancy devices such as grantor retained annuity trusts, charitable lead and remainder trusts, family limited partnerships, etc. Too often, I think, we may not pay as much attention to the availability of the disclaimer as a planning option in our administration of estates and trusts and in our efforts to assist surviving family members. I therefore suggest to you my own Top Five list of reasons why disclaimers should be highly regarded: Reason No. 1. When compared to the bevy of devices available for tax planning, such as charitable trusts and grantor retained interest trusts and personal residence trusts, the disclaimer is just plain Less Complicated. We don't have to worry about IRS applicable interest rates, or whether the grantor will survive the term of the trust, or whether the property will appreciate, or any of the many other factors inherent in much of our contemporary planning. As long as we help the beneficiary to timely touch all the right bases, the disclaimer will be effective. Second reason. Normally, the potential benefit of a disclaimer is readily Quantifiable. No need to project growth rates or calculate income tax costs. Generally, what a beneficiary disclaims is exactly what the taker in default gets, free of transfer tax costs. Reason No. 3 is Flexibility. Since a disclaimer need not involve an all-or-nothing proposition, a beneficiary can disclaim one portion of a benefit and keep the balance. If a trust has been created for A, with the income payable to A until age 50, at which point the principal is payable to A's children B and C in default of A's exercise of a power of appointment, A can keep the separate income interest and disclaim the power of appointment (which he might be well-advised to do if the power is a taxable general power). Treas. Reg. § 25.2518-3. Our Mr. A can disclaim a benefit passing to him at someone's death or a gift during lifetime (as long as there is a contingent taker). Mr. A can disclaim assets left to him under a Will, or any of a variety of non-probate assets such as life insurance and joint bank account interests. In fact, the Federal tax and New York property law rules have been so altered over the last 22 years (going back to the 1976 Tax Act) that -- as long as a beneficiary acts timely -- our Mr. A may be able to find a way to effectively disclaim almost any interest. Another reason to highly regard disclaimers is, in one word, Elegance. As attorneys planning generational and other transfers, we welcome an element of elegance in our plans. To me, when a beneficiary gives due consideration to an arrangement and then gracefully declines to accept the benefit (or a portion of it) so that, with no direction or control on the part of the disclaimant, the benefit flows along naturally to the next beneficiary, the end result is an elegant one. Life insurance trusts with Crummey-withdrawal powers may be considered somewhat contrived and therefore are not very elegant. Neither are intentionally defective grantor trusts. Nor family limited partnerships funded with marketable securities with the likelihood of an IRS audit of the discount. Disclaimers are elegant. Reason No. 5 to highly regard disclaimers is that the act of disclaiming can be Empowering. Sometimes an elaborate estate plan is devised by a senior family member. While the plan may be incorporated in a well-drafted Will or trust, the arrangement ultimately may not be perfect from the viewpoint of a junior family member who is a beneficiary. The opportunity to disclaim can give the junior family member a way to adjust things, a personal option which cannot be exercised by the Executor or any other family member. It is the junior family member, our Mr. A, who alone can make an important decision which will impact the disposition of a part of an estate. When Mr. A reflects on the possibility, assures himself that he understands the consequences and gracefully declines the benefit thereby causing it to flow naturally to the taker in default, he experiences a sense of empowerment. In an estate administration context, the disclaimer option is similar to all those tax elections which the designated Executor is authorized to make, (i.e. whether to take deductions on the estate tax return or the fiduciary income tax return, whether to make a full QTIP marital deduction election, where to allocate the generation-skipping transfer (GST) tax exemption, etc.). The one big difference is that all these tax law elections must be made by the Executor. The disclaimer, on the other hand, can only be effected by the beneficiary -- who is perhaps a junior family member wondering why father didn't name him or her as an Executor, and this gets us back to the empowerment notion. Beneficiary v. Fiduciary Disclaimers A disclaimer is simply a "refusal to accept" a benefit or interest under a testamentary or lifetime instrument of transfer. The powerful advantage for the disclaimant is that the benefit or interest will then pass to another person, the contingent taker, without any gift tax cost to the disclaimant. Of course, in order to have a qualified disclaimer, there must be no acceptance by the disclaimant and no control exercised by him or her in passing along the benefit. Because the act of disclaiming, or "renouncing," must also be unconditional and irrevocable, Mr. A cannot execute a qualified disclaimer document on Monday and change his mind on Tuesday. And, of course, the disclaimer must be timely. In general, when we think of disclaimers, we think of a beneficiary exercising a right to disclaim. There may be situations, though, where it would be useful for a fiduciary to disclaim, as where we wish to qualify a trust for QTIP marital deduction treatment but the fiduciary powers granted to the Trustee are too broad. One simple remedy for this situation would be for the Trustee to disclaim the offending power. A word of caution here. In New York and many other states, a disclaimer by a fiduciary may be problematic since the Court may consider a Trustee as standing in the shoes of generations of contingent beneficiaries and, thus, incapable of voluntarily disclaiming. To effectively disclaim a power in New York, the fiduciary generally needs one of two things: An enabling clause in the Will or trust instrument (that is, a clause specifically authorizing the fiduciary to disclaim any power granted under the Will or applicable law, with a provision that any disclaimed power is void and may not be exercised by any successor to the disclaiming fiduciary), or the order of a court of appropriate jurisdiction approving the relinquishment of the power (which is not unlike a judicial reformation). To be safe, we prefer both the clause and the court order. Tax and Non-Tax Objectives The objectives which may be achieved by exercising a disclaimer fall into two basic categories. Most of the time, a beneficiary will disclaim for a tax-related reason. The tax objective may be to simply accelerate the gift tax-free transfer of property to the next generation, or perhaps to take greater advantage of the marital deduction, the GST exemption or some other credit or deduction. Frequently it will be used in a situation in which a wealthy spouse left her entire estate to her equally wealthy surviving spouse, without taking advantage of her Unified Credit (currently $625,000, and scheduled to rise to $1 Million by 2006). A disclaimer can accomplish all of these tax purposes and obtain substantial savings for the beneficiaries. A disclaimer can also be used to adjust the disposition of assets when there is no tax benefit to be had. I have had estate situations in which a harsh result affecting one family member was corrected with a disclaimer. In one estate, a sister effectively disclaimed a portion of a bequest in order to pass more assets to her brother. There was no tax benefit (and also no tax disadvantage), but after the disclaimer the family harmony quotient received a big boost. Often, non-tax benefits can be more rewarding for a family than an elaborate tax-savings move. Timing The element of Timing is key to a successful disclaimer, and Carolyn Glynn will touch on this perhaps most tricky mechanical aspect. In an estate administration context, this element can create a degree of tension which the professional advisor must anticipate and control. When an opportunity for a disclaimer is identified in an estate, the best time to discuss the opportunity may not be immediately after death. If a close relative dies, family members may experience a measure of post-death shock, and want to move as expeditiously as possible through the estate administration process, focusing primarily on dealing with their own grief or caring for a surviving senior family member. That which the deceased family member has written in his Will may be deemed carved in stone. Under these circumstances, any mention of the merits of refusing to accept a benefit decreed by a recently deceased senior family member can be met with indifference or possibly suspicion. We respect this, because no one wishes to incite dissatisfaction with the deceased family member's intentions as expressed in a carefully drawn Will. Nor do we wish to slow down the administration process. (In fact, maybe attorneys sometimes overlook disclaimers subconsciously, preferring to complete the administration process and ensure that the artful terms of our Will have not been tampered with.) So, knowing when to describe the option and its consequences/benefits to a beneficiary may require some sensitivity. This can mean delaying an aspect of an estate in administration until the beneficiary is in a frame of mind to appreciate the advice. At the same time, we cannot take too long to inform a beneficiary of the option. We cannot wait until the beneficiary has already accepted the benefit or interest. We cannot delay to the point where the nine-month statutory period is about to expire, or else any disclaimer will have adverse tax consequences. One point is clear. If a professional advisor is aware of a circumstance suggesting a disclaimer, we should find a way to communicate the option to the beneficiary. A family's confidence in our professional advice will be eroded if we proceed without calling it to the attention of the beneficiary and then he or she discovers too late from another source about the lost opportunity. So, there is a tension between, on the one hand, the need to timely disclaim in order to be tax-effective and, on the other hand, the post-death shock which sometimes makes the subject painful for the grieving beneficiary whose focus is elsewhere. I think the best recommendation for dealing with this tension is to be both alert to the option and sensitive to the beneficiary's circumstances. A final word relating to Timing. Under the current tax statute, § 2518, a disclaimant must act within nine months after the transfer creating the interest. Under pre-1977 law, however, an interest could be disclaimed "within a reasonable time" after a beneficiary has knowledge of the interest. This means that there will still be instances in the future where interests in trusts created prior to January 1, 1977, the effective date of § 2518, may be effectively disclaimed for U.S. gift tax purposes. Four IRS Private Letter Rulings issued in September of this year approved tax-free disclaimers by remaindermen of trusts created in 1958 in which in each case the disclaimant apparently had no knowledge of the interest until late 1997, and a disclaimer of the interest was qualified under applicable state law (in this case, Alabama). So, even in old instruments, the opportunities may exist. Many pre-1977 trusts will have enjoyed significant appreciation. Consequently, identifying a genuine disclaimer opportunity in a pre-1977 trust which is not includible in a current estate may make a major impact on the financial future of a family. If the beneficiary genuinely lacked knowledge, the shock of discovering the existence of the trust interest may be surpassed only by his or her delight in the tax benefits which will accrue to junior family members as a result of a disclaimer. Disclaimers are simple, flexible, quantifiable, elegant and sometimes even empowering estate planning options which, in an appropriate circumstance, can have a meaningful impact on the future financial and emotional well-being of a family. STATUTORY REQUIREMENTS: U.S. TAX LAW AND NEW YORK PROPERTY LAW Ms. Glynn: A "Valid Disclaimer" The effect of a valid disclaimer is as though the disclaimant predeceased the transferor, causing the property interest to pass to the next beneficiary in line without incurring an additional taxable event. The key question, therefore, is what constitutes a "valid disclaimer?" Under common law, which applied to pre-1976 transfers, it was often difficult to tell because the test was rather subjective. Based on the facts of each case, the court had to establish whether the disclaimant made the refusal within a "reasonable time" after his "having knowledge" of the transfer. These two elements were not always easy to prove. Thanks to the enactment of § 2518 of the Internal Revenue Code for Federal purposes and § 2-1.11 of the Estates, Powers & Trusts Law of New York ("EPTL") for New York purposes, a person can make a valid disclaimer of a post-1976 testamentary or inter vivos transfer, provided certain objective, mechanical requirements are met. As you can see from the accompanying chart, I have listed the formal requirements under both statutory schemes, which are, by and large, quite straightforward and which parallel each other. For the most part, the requirements are self-explanatory overall and do not invite different interpretations. One semantic distinction, though, is that under New York law the act of refusing an interest in property is called a "renunciation" rather than a "disclaimer." This is a carryover from common law and although it is really a distinction without a difference, the term "renunciation" appears throughout the New York statute.
Time Period The most problematic of the requirements under both statutes (and the most often litigated issue) is the requirement in item 4 of the chart -- the nine-month timeframe within which a person must disclaim. The critical issue is in finding the starting point for the nine-month period. As a general rule, the nine-month period begins to run when the "interest in the property is created." But that begs the question: "When is the interest in property created?" As a starting point, the Treasury Regulations provide that an interest in property is created for purposes of a disclaimer at the time there is a "taxable transfer." In turn, finding the "taxable transfer" often depends on the nature of the property being transferred. How does this work in practice? Outright inter vivos and testamentary transfers are easy to see. The interest is created as of the date the transfer is complete for gift tax purposes if the transfer is inter vivos, or the date of the decedentıs death if the transfer is testamentary. But, what if the interest is in trust? That will depend on whether the trust is revocable or irrevocable. Once again, we need to look for the date on which there is a "taxable transfer" to mark the starting point. For example, if Father creates an irrevocable trust for the benefit of Daughter with income to daughter for her life, and then upon Daughter's death, remainder to Grandchild, Grandchild will have nine months from the date the trust is created to disclaim his remainder interest, even though such interest may not vest in Grandchild for many years after the trust's creation. This is because the taxable event is the creation of the trust. By contrast, if Father instead creates a revocable trust for himself, providing for income to Daughter following Father's death, with the remainder passing to Grandchild upon Daughter's death, Grandchild will have nine months from Fatherıs death rather than the earlier date of the trustıs creation to disclaim his remainder interest. In the latter scenario, no taxable transfer occurs until Father's death. What if the interest transferred is the result of the exercise or default of the exercise of a power of appointment? To answer this one, you must first determine whether the power holder had a special (or limited) or a general power of appointment. If the interest in property is created by the exercise or default of a special power of appointment, the nine-month period within which the appointees or takers in default must disclaim begins at the creation of the trust, a taxable event. But, if the interest in property is created by the exercise or default of a general power of appointment, the time within which the appointees or takers in default must disclaim is deferred until the power holder exercises that power, whether during his life or at his death, or fails to exercise it. As an illustration, suppose Father created an irrevocable trust giving Daughter a limited testamentary power to appoint the trust property to Grandchild. Grandchild would have nine months from the date the trust was created to disclaim his remainder interest in the trust. By contrast, if instead Father gave Daughter a general testamentary power of appointment and Daughter exercised the power in favor of Grandchild by the terms of her Will, Grandchild would have nine months from Daughter's date of death (the effective date of the exercise of the testamentary power) rather than the earlier date of the trust's creation. The major exception to the "nine month from the date of transfer" rule applies to a disclaimant who is younger than 21 on the date the taxable transfer is made. Under Federal law, a disclaimant has nine months from his 21st birthday to disclaim, even though state law may treat him as a person of majority at an earlier age. Under Federal law, this is the only exception to the general rule and there is no tolling of the nine month period for any other disability. Turning to New York on this point, although the EPTL does not contain an express exception for beneficiaries under age 21, the courts have allowed extensions for under age beneficiaries to make their renunciation, even after the nine month period has elapsed, in order to be consistent with the Federal statute. Matter of Kravis, 154 Misc.2d 236, 584 N.Y.S.2d 274 (N.Y. Co. 1992). Legislation has been proposed to revise the EPTL to expressly provide for this tolling. For purposes of New York law, there are two other exceptions: the first is what I call the "reasonable cause exception" and the second is the "future interest exception." Generally, the time for filing and serving a renunciation may be extended, within the court's discretion, even after the nine month period has expired upon a showing of "reasonable cause." Reasonable cause was found when the beneficiary did not know the extent and complexity of the liabilities attached to the property interest and was, therefore, not in a position to administer the property. Matter of Edmonson, N.Y.L.J., Jan. 18, 1994, at 29, col. 3 (N.Y. Co.). Reasonable cause has also been found where the beneficiary was not aware of the extent of the value of the bequest and accepting it would have negatively impacted her own estate plan. Matter of Ludecker, N.Y.L.J., Feb. 1, 1990, at 30, col 6 (Suffolk Co.). Under the "future interest exception," if the property interest is a future estate, the renouncing party has nine months from the date on which the interest actually comes into possession, or vests in him, to make his renunciation and cause the property to pass to the next beneficiary in line. It is important to note that these two exceptions are for New York purposes only, and do not serve as exceptions to the timing requirements for making a qualified disclaimer for Federal tax purposes. Another distinction between the New York and Federal statutes relates to the nine-month period in connection with multiple, successive interests. Under Federal tax law, all successive interests in the property must be disclaimed within the original nine-month period. For New York purposes, however, if the interest of the renouncing party is created as a result of a prior renunciation by another person, the nine-month period runs from the date of the prior renunciation rather than the date of the original transfer. No Acceptance The second most problematic of the requirements is that there be no acceptance by the disclaimant. The Treasury Regulations provide that acceptance is manifested by any affirmative act that would be consistent with ownership of the property, such as the use of the property, the receipt of dividends or income from it, pledging it as security or agreeing to encumber it in exchange for other assets, or directing others to act with respect to it, such as in the case of caretakers of real estate. In addition, the receipt of any consideration in exchange for making the disclaimer constitutes acceptance of the entire interest being disclaimed. But acceptance can also be inadvertent and implied from the circumstances. In an IRS Memorandum, a wife died shortly before her husband. The wife's Will included a marital deduction general power of appointment trust for the husband. The husband's Will exercised his power of appointment to the extent necessary to pay death taxes attributable to the property held in the marital trust. After the husband's Will was probated, his Executor sought to disclaim his entire interest in the marital trust. The IRS held that his Will effectively exercised the power before the disclaimer was accomplished so that there was acceptance by the husband and no valid disclaimer. TAM 8142008. The facts of this Memorandum became incorporated as an example in the Regulations, with the exception that if the husband properly disclaimed the property before his death, his disclaimer would be valid, even if his Will had purported to exercise the power. Treas. Reg. § 25.2518-2(d)(4) Ex. 7. Who may disclaim? The beneficiary himself, of course, may disclaim. So may the fiduciary of the estate of the beneficiary, the guardian of an infant, the committee of an incompetent, or the conservator of a conservatee. Under the New York General Obligations Law, a person acting pursuant to a power of attorney may disclaim on behalf of the disclaimant. Although EPTL § 2-1.11 does not expressly authorize this, there is proposed legislation to revise the EPTL accordingly. Where a fiduciary is acting on the behalf of another, the fiduciary must be authorized by the ward or the court. In the case of an infant disclaimant, the court will look to where the ultimate benefit flows and whether or not there is a conflict of interest before allowing the guardian to disclaim on his behalf. For example, in one case where a mother, as the guardian of two minor beneficiaries, sought to disclaim the minors' interests in their father's estate in order to create a larger marital deduction and therefore create a tax savings, the court found that the ultimate economic benefit inured to the mother rather than the children and disallowed her renunciation on their behalf. In re De Domenico, 100 Misc. 2d 446, 418 N.Y.S.2d 1012 (Nassau Co. 1979). As a practical matter, a disclaimant should try to meet all of the mechanical requirements of the statutes as early as possible. For example, there could be difficulty in identifying the parties entitled to notice under New York law and in making proper service of the notice on them. It is important to remember, too, that acceptance can be implied from the circumstances regarding the transfer of the interest, and that if any degree of acceptance can be established, the entire interest is considered accepted and the disclaimer a complete nullity. Logically, the more time that elapses between the transfer of the interest and the actual compliance with the statute, the greater the risk that intervening circumstances could amount to constructive acceptance. Irrevocability Finally, a disclaimer or renunciation is irrevocable, without exception. Even if all interested parties consent to the renouncing party's revocation of a renunciation, and no persons will be prejudiced by the revocation of a renunciation, the renouncing party is prohibited from withdrawing his renunciation. In re Estate of Munch, 125 Misc. 2d 610, 480 N.Y.S.2d 95 (Nassau Co. 1984). In sum, although the mechanical requirements are easy to understand on their face, there are some serious considerations beneath the surface. First, identify the time frame within which to start the disclaimer process. Second, make sure that the disclaimant is sure of his disclaiming posture under both the Federal tax statute and applicable state law, as there is no second chance at receiving the property interest once disclaimed. CREATIVE USES OF DISCLAIMERS Mr. Stutzman: In many of the cases that a trust or estate counsellor will encounter a disclaimer, it will be because circumstances have changed between the day that the decedent's Will or trust was signed and her date of death. Or sometimes the specific language in a Will or trust may cause unwanted tax consequences. Or sometimes the decedent's surviving relatives may have a very different idea of how the estate should be settled then the decedent did. In all of these cases, a qualified disclaimer may be the best solution to an estate plan that may otherwise go awry. There are many opportunities for disclaimers in estate planning and administration. I will touch on a few options here, namely the use of disclaimers in marital planning and in gifting programs, the recently finalized joint tenancy disclaimer regulations, and a few ways to make use of disclaimers in retirement planning. Post-death Marital Planning A frequently seen disclaimer is prepared ahead of time for use in marital planning -- usually in the form of a credit shelter (or bypass) disclaimer trust. For instance, Husband and Wife have estates that don't quite reach the maximum credit shelter amount, but they are confident of future financial success. An estate planner may recommend that each of Husband and Wife include in his or her Will an outright gift of the residuary estate to the other, but provide that if the surviving spouse disclaims his or her interest in all or a portion of the bequest, the disclaimed portion (up to the amount of the deceased spouse's available applicable credit amount) will pass into a credit shelter trust for the surviving spouse's benefit. If the family's finances have improved substantially by the time Husband dies, use of the disclaimer by Wife may result in significant tax savings. By disclaiming her outright bequest into the credit shelter trust, which could be set up for her benefit, anything held in that trust at Wife's subsequent death would be shielded from estate taxes at her subsequent death. If Wife had instead inherited everything outright, there could be substantial taxes at her later death (because Husband's entire estate would have been added to her estate). Provided Wife is granted only an ascertainable standard with respect to principal invasions, she could even serve as a Trustee of the trust without unwanted estate tax consequences. In an increasingly global economy, with cross-border marriages involving citizens of different countries, disclaimers can offer great flexibility in planning. Since 1988, the unlimited marital deduction has not been available for transfers to non-citizen spouses (with certain exceptions). Transfers to a non-citizen spouse in excess of the applicable credit amount are taxable unless made in the form of a qualified domestic trust (or QDOT). Many times, however, a citizen and his non-citizen spouse are unsure as to whether the non-citizen spouse may attain U.S. citizenship. In such cases, one can include in a Will or revocable trust disclaimer provisions to allow the surviving non-citizen spouse to disclaim an outright bequest or QTIP trust into a QDOT if she has not attained U.S. citizenship by the time her husband's estate tax return is required to be filed. Even if the drafting attorney never knew about the fact that the surviving spouse was not a U.S. citizen until the death of the citizen spouse, it may be possible to cure a "defective" QTIP trust by arranging for a disclaimer of any offending powers, either by the surviving spouse or by a Trustee so as to qualify the trust as a QDOT. Disclaimers in marital planning can also provide post-death gift giving opportunities. Where Husband and Wife may have had an annual gifting program in place but had not planned for substantial testamentary gifts to their offspring, with the result that the entire estate of Husband passes to Wife at his death, Wife can pass assets down the generational ladder by disclaiming an amount sheltered by Husband's remaining applicable credit amount. In this way, under current laws, up to $625,000 of Husband's estate could pass tax-free outright to the couple's children and/or grandchildren, if they are the contingent beneficiaries of the estate. Alternatively, if Husband's estate is considerably smaller than Wife's estate, a disclaimer by Wife of her interest in Husband's estate, if it results in a taxable estate for Husband's estate, could result in lower overall estate taxes for both estates, by subjecting a portion of the couple's estates to tax in each estate so as to lower the overall estate tax bracket. Wife, as the survivor, could even consider making a partial disclaimer, pay some estate tax and possibly make a partial QTIP election in order to utilize the previously taxed property credit. Sometimes, the surviving spouse and family may want to increase the size of the property passing to the surviving spouse. Disclaimers of interests by beneficiaries other than the surviving spouse may pass property to or for the benefit of the spouse under the instrument or, if the deceased spouse had no Will, through intestacy, thus deferring any estate taxes until the death of the surviving spouse. (In this scenario, as in any disclaimer situation, one should beware of "wrong-way" disclaimers, such as a disclaimer by a child, who expects that by disclaiming her interest, it will pass by intestacy to her parent, not realizing that the share instead may pass to her child.) Disclaimers as Disguised Gifts Even outside of the context of marital planning, disclaimers can be used to pass assets down the generational ladder at lower gift tax cost and to take advantage of lower tax brackets. This is a straightforward way to coordinate the disclaiming recipient's gifting program with that of the donor. For example, Child may have done well financially and may not need the bequest Mother has left him. Provided he makes a qualified disclaimer, he can effectively give Mother's bequest to the contingent beneficiary of the gift, who may be his children, at no gift tax cost. There are, of course, GST tax consequences to such a disclaimer. But this shouldn't disqualify the option. Instead, this may be an opportunity for the child to take advantage of the decedent donor's remaining GST exemption with a disclaimer of property equal to the amount of the remaining exemption, or to limit the amount of any generation-skipping transfer to his children from the deceased grandparent to the amount of the grandparent's remaining exemption. The family may even want to incur some GST tax by arranging for a disclaimer of more than $1 million of the decedent's property, so as to pass that extra amount downstream. The GST tax on a direct skip is calculated on the net received and does not include the GST tax itself. The GST tax on a taxable termination, however, which might occur if the property were not disclaimed but instead remained in trust for the child's benefit until his death (at which point it would be paid out to the grandchild) is tax inclusive (i.e., the taxable amount includes the property used to pay the tax), resulting in a higher GST tax. (On the other hand, the tax on a direct skip is due at the transferor's death whereas the tax in the case of a taxable termination is due upon the death of the child-beneficiary). Just as a beneficiary may disclaim in favor of his children, he may also disclaim in favor of a charitable contingent beneficiary, thereby allowing his bequest to pass to the charity at no cost. This manoeuver is especially attractive if the decedent's estate tax rate is higher than the disclaimant's income tax rate, resulting in a greater leveraging between the charitable estate deduction and the charitable income tax deduction. Final Joint Tenancy Regulations Under final new joint tenancy regulations, effective for transfers made after December 31, 1997, it is now possible for a surviving joint tenant to disclaim her survivorship interest in a joint tenancy. The impact of these regulations may be that in many cases planners will not have to press our clients to unbundle joint tenancy assets to fully utilize their applicable credit amounts. Under the new rules at Treas. Reg. § 25.2518-2(c)(4), if Wife contributes $1 million (and Husband nothing) to the purchase of Blackacre and they take title to Blackacre as joint tenants, Husband succeeds to a 50 percent joint interest in the property. If Husband wants to disclaim his 50 percent interest in Blackacre, he must do so within nine months of its purchase. But with respect to Wife's interest in Blackacre, Husband has nine months after Wife's death within which to disclaim. This new rule is effective regardless of whether the interest can be unilaterally severed under local law, and applies regardless of the levels of contribution of each spouse. Special provisions relating to bank, brokerage and investment accounts held jointly provide that if, under local law, the contribution of assets to such an account is not a completed gift under the gift tax regulations, the surviving joint tenant may exercise a disclaimer within nine months of death of the contributing joint tenant with respect to any interest in the account, because until her death the contributing joint tenant could have unilaterally removed her contribution from the account. No portion of the account attributable to contributions of the disclaimant may be disclaimed, both in spousal and nonspousal joint tenancies. This exception will be less meaningful in New York where such a contribution would be considered a completed gift. The new joint tenancy disclaimer provisions may simplify both pre- and post-mortem planning. Estate planners often worry that clients may not make full use of their applicable credit amounts when much of their property is owned in joint tenancy, because such property passes by operation of law and is unavailable for satisfying the predeceased spouse's applicable credit amount. Under the new regulations, a surviving spouse may disclaim his survivorship interest in joint property, thereby allowing the property to pass under the predeceased spouse's Will (where it could form part of a credit shelter trust, for example). Retirement Planning Finally, a word about retirement planning, one of the more cumbersome areas of estate planning and administration. Disclaimer possibilities in this field are somewhat limited. With planning, a surviving spouse may disclaim his interest in his predeceased wife's retirement plan, with a trust as the contingent beneficiary. During the lives of the participant and her spouse, required distributions could be made from the plan using a combined life expectancy, with annual recalculation if desired. At Wife's death, Husband can disclaim his interest in the plan, so as to fund a credit shelter trust for his benefit (similar to our first example) or a QTIP trust, or even a charitable remainder trust. Disclaimers may also be executed by nonspousal beneficiaries to preserve spousal rollover treatment. Thus, if instead of her spouse, the participant had named her children, estate or a nonqualified trust as beneficiary of her plan, the execution of successive disclaimers by all interested persons in the estate (even intestate heirs) or the trust to the extent of their interests in the plan distribution could allow the plan assets to pass to the surviving spouse for rollover treatment (as well as to defer estate taxes), as long as the plan designates the spouse as contingent beneficiary. Where there is no surviving spouse, a disclaimer by a named beneficiary in a high income tax bracket in favor of a contingent beneficiary in a lower tax bracket may result in the deferred income being subject to a lower income tax bite as it is received. Disclaimers should be considered in estate planning and administration, during life and after death. Some opportunities may be spotted early, before death makes the result inevitable. But even when death comes, disclaimers may be available and advantageous. To preserve a credit shelter amount or a marital deduction, to reduce taxes charged against a non-citizen spouse, to transfer assets up- or down-stream, to unbundle joint tenancy property, or even to correct a retirement plan -- disclaimers, when done properly and timely, can dramatically improve the outcome of an estate plan. IMPACT OF FALLING INTEREST RATES ON SPLIT-INTEREST TRUSTS In January, 1994, our Report to Clients stated: "The IRS discount rate, which affects the valuation of gifts under certain estate planning techniques, was lower at the end of 1993 than at any time during the last several years." The IRS applicable interest for November 1993 was 5.91 percent. This November, the rate finally dropped below that level, and rests at 5.34 percent. Interestingly, with lower rates, certain split-interest estate planning instruments become more favorable to the taxpayer. We present, therefore, our list of What's In and What's Out (and What's Not Affected) in split interest planning in a low-rate era:
RESTORATION OF FULL DEDUCTIBILITY FOR QUALIFIED APPRECIATED SECURITIES GIFTED TO A PRIVATE FOUNDATION On October 21, 1998, President Clinton signed into law tax legislation making permanent the ability of a donor to take a full fair market value income tax deduction for gifts of appreciated stock made to a private foundation. The provision, one of several in the Tax and Trade Relief Extension Act of 1998 designed to restore expiring tax provisions, is retroactive to June 30, 1998, the date on which this provision had previously expired. Under the new legislation, a taxpayer who contributes qualified appreciated securities (for which there are readily available market quotations) to a private foundation described in § 509 of the Internal Revenue Code will now be entitled to deduct the full fair market value of the securities. This provision has expired at least twice in the past. Making it permanent should provide comfort to donors who prefer to make gifts to private foundations rather than directly to public charities. Private foundations may appeal to those persons who would wish to engage themselves and/or family members in ongoing charitable giving. Contributions of appreciated securities may be made annually to the private foundation. With certain income limitations, an income tax deduction for the full fair market value of the appreciated securities may be taken for the year in which the contribution is made. Under current rules, at least five percent of the value of the foundation assets must be distributed to public charities each year. Also, the directors of a private foundation may include family members of the donor. This report is distributed for general information purposes only. No action should be taken solely on the basis of its contents. ©1998 Dunnington, Bartholow & Miller LLP. All Rights Reserved. |