Thanks for Thinking of Me, But No Thank you
Would anyone ever want to say, “No, thank you, I don’t want it,” to an inheritance? Actually, yes! There are many reasons that a beneficiary of an estate may not want to receive an inheritance. For example, a beneficiary may not need the money, a beneficiary may want the assets to pass to someone else, or it may be estate tax advantageous for such beneficiary not to receive the property. However, from a state law perspective and a federal estate and gift law perspective, it is not as easy as just saying, “I don’t want it; give it to someone else.”
From the moment of death, a beneficiary has a vested right to receive the inheritance provided to him or her under a decedent’s estate plan. Therefore, if the beneficiary, after death, states that he or she does not want the property, he or she will be treated as receiving the inheritance and making a gift of the inheritance to whomever he or she directs the property to be distributed. This is true even if the beneficiary never holds the property in his or her hands or never controls or has access to the money. If the “gifted” inheritance is over the annual gift tax exclusion amount (currently $12,000), then the beneficiary will be treated as making a taxable gift to the other person and will be required to file a gift tax return.
There is an alternative, however, under both state law and federal estate and gift tax laws that allows a beneficiary to say, “I don’t want it,” and be treated as never owning the property and not making a gift of the property; this is known as a “qualified disclaimer.”
The phrase “qualified disclaimer” is a term of art within the Internal Revenue Code, Section 2518. If one executes a qualified disclaimer, he or she will be treated as if the disclaimed property was never transferred to him or her, and the disclaimed property will pass under the testator’s estate plan as if the disclaimant predeceased the testator. A disclaimer that is qualified for federal estate and gift tax purposes will also be recognized as valid under Florida property laws. Thus, a beneficiary can say, “No thank you,” to an inheritance without incurring any federal gift tax liability.
To be a qualified disclaimer under the Internal Revenue Code, certain requirements must be satisfied:
- The disclaimer must be in an irrevocable signed writing that is delivered to and received by the appropriate party before nine months after the decedent’s date of death.
- The disclaimant must not have accepted any interest in the property or benefits of it before the disclaimer.
- The disclaimant must not direct where the property passes.
- The disclaimant may not receive any interest in the disclaimed property after the disclaimer unless the disclaimant is the spouse of the decedent.
Although there are many times that a disclaimer may be used, there are two classic scenarios. First, Parent is the beneficiary of an estate and would prefer that his or her children receive the inheritance. Typically in this scenario Parent previously established an annual gifting program to the children, Parent is comfortable with his or her accumulated assets and income, Parent is likely to have a taxable estate at death, or Parent wants to protect the disclaimed assets from future creditors or spouses. Since Parent may not direct the disposition of the disclaimed property, the estate plan of which Parent is a beneficiary must provide that if Parent predeceases the testator then the Parent’s share passes to either Parent’s then living children or Parent’s lineal descendants, per stirpes. If so, Parent may execute a qualified disclaimer and the disclaimed property will pass directly to Parent’s children or lineal descendants without Parent incurring any federal gift tax liability.
The second classic scenario to use a disclaimer is when a spouse is the beneficiary of his or her spouse’s estate such that the applicable exclusion amount that may be passed free of estate tax in the first to die spouse’s estate is not fully utilized. In this scenario, a couple’s estate planning documents may provide that each spouse’s entire estate is devised to the other, outright and free of trust. Since the marital deduction is available to pass an unlimited amount of assets to a spouse free of estate taxes (assuming two US citizen spouses), there will not be any estate tax at the first death. Estate taxes, if any, will only arise at the second death and only to the extent the assets of the surviving spouse exceed his or her available applicable exclusion amount. (The applicable exclusion amount is scheduled, under the current tax law, to gradually increase from $2 million in 2006 to $3.5 million in 2009 and to an unlimited exemption in 2010).
If it is anticipated that the assets owned by the surviving spouse at the time of his or her death will exceed his or her available applicable exclusion amount, the surviving spouse may disclaim some or all of the assets of the deceased spouse’s estate to utilize some or all of the deceased spouse’s applicable exclusion amount. Such a disclaimer can pass more assets to the ultimate beneficiaries of the combined estate plan free of federal estate tax.
Be careful of one possible outcome, however. If the testator’s estate plan is drafted in such a way that the estate is distributed to his or her children if he or she is not survived by a spouse, the disclaiming spouse must carefully consider whether he or she can maintain his or her standard of living without the disclaimed assets, since the disclaimed property will be immediately distributed to the children at the time of the disclaimer.
This scenario provides a good pre-death estate planning opportunity. An estate plan may be structured to create a trust to hold any assets disclaimed by a surviving spouse for his or her lifetime benefit. Such a disclaimer trust plan allows a surviving spouse to execute a qualified disclaimer to fully utilize the applicable exclusion amount of the first spouse to die and still have the benefit of the disclaimed assets during his or her lifetime. In this sort of plan, a spouse does not have to worry that he or she will not be able to maintain a standard of living because assets were transferred to their children before both spouse’s deaths. Any beneficiary other than a spouse may not receive the benefit of any disclaimed assets after the disclaimer; therefore, a disclaimer trust plan will only be available to benefit a surviving spouse.
Disclaimers provide many opportunities for both pre-death estate planning and decision making after a death has occurred. Feel free to go ahead and say, “No, thank you,” to an inheritance, but be sure that you do it in a tax-neutral way by executing a qualified disclaimer.
For more information regarding this article, you may contact Rose-Anne Frano at 941-536-2033 or at rfrano@williamsparker.com.