Disclaimers provide a useful post-mortem technique to fine tune an estate during its administration. On every estate or trust administration lawyer’s check list ought to be a reminder to see if a disclaimer should be used.
Good estate planning requires structuring wills and trusts with sufficient flexibility to address the various potential situations that may exist at the client’s death. One technique often used by estate planning lawyers to maintain this flexibility is to build into the estate planning document alternative dispositional structures to address different circumstances. When the death occurs and the plan becomes operative, a disclaimer may enable the primary heir, generally designed to be the surviving spouse, to determine the best alternative and essentially pick the appropriate structure to control the disposition of the assets. The reason disclaimers are often designed for the surviving spouse is because under the federal tax code, only a surviving spouse can use a disclaimer to restructure a bequest that then continues for the primary benefit of the disclaiming spouse.
The mechanism used is to permit the surviving spouse to “select” how the property should flow at death is by making a qualified disclaimer. If the estate planning documents contemplate using a disclaimer to ultimately determine disposition of assets, it is important that an informed decision be made to disclaim or not disclaim early in the estate or trust administration.
Because of its importance in estate tax and asset protection planning, anyone administering an estate or trust should carefully examine the planning document to see if disclaimer planning is a feature of the plan. If so, you should discuss with your estate administration lawyer the pros and cons of exercising a disclaimer. A timely decision must be made to use or not use the disclaimer.
In the world of estates and trusts, a disclaimer is a refusal to accept a gift or a bequest. It may sound strange to refuse a gift but a disclaimer is a useful tool for tax, asset protection and estate planning. A disclaimer is when the recipient (called the “donee”) refuses a bequest, for example, the donee refuses an inheritance left in a will or trust, refuses the proceeds from an account labeled as pay-on-death account when the original owner dies, or refuses the surviving interest in jointly owned property when one joint owner dies.
To implement a disclaimer, one needs to apply a mix of federal tax regulations and Maryland substantive law provisions. The two are not the same. The most important difference is that under federal tax regulations a qualified disclaimer must be made within nine months of the transfer. Under Maryland law, no period of time limits the exercise of a disclaimer, but the exercise is prohibited once the donee accepts benefits from the transferred property.
To be effective, a donee when exercising a disclaimer must make a pure refusal to accept the bequest. A donee cannot “refuse” a bequest and, at the same time, direct where the bequest should go as a result. A will or trust may include a disclaimer clause which controls a disclaimed bequest. If a clause is not included, a disclaimed bequest is typically distributed under the governing instrument as if the recipient predeceased the testator (for Wills) or settlor (for trusts).
Federal tax regulations defines a “qualified disclaimer” and requires that a qualified disclaimer must generally be made within nine months of the death of the testator or within nine months after the occurrence of the transfer creating the property interest being disclaimed. A qualified disclaimer is not a gift from the donee making the disclaimer so the bequest will not be subject to federal gift taxes against the disclaimant.
Under Maryland law, and generally under the common law, creditors of a disclaimant cannot attach disclaimed property. This flows from the premise the disclaimant never receives the property in the first place. Under both federal qualified disclaimer rules and under Maryland statutory law a disclaimer must take place before the disclaimant accepts an interest in or benefit from the property.
A potential disclaimant should make a decision whether to disclaim property early in the estate administration process. It is a conversation that you need to have with your estate administration lawyer before you inadvertently take a disqualifying action. In one case, the IRS held that the disclaimer was not qualified for federal tax purposes because the surviving spouse listed the asset on a loan refinance application as “his” asset. That violated the requirement that a qualified disclaimer must be made before taking a benefit from the interest intended to be disclaimed.
A disclaimant generally makes a disclaimer for two reasons: tax and/or asset protection purposes. Both are usually tied to whom has access to the property after the disclaimer is effectuated.
A donee may want to make a disclaimer for tax purposes. Many estate plans provide that in the event of a qualified disclaimer, the gift falls into trust for the benefit of the surviving spouse. If properly constructed, the disclaimed property goes into trust for the surviving spouse, which then avoids being included in the surviving spouse’s estate for tax purposes. While both Maryland estate tax and federal estate tax laws permit a surviving spouse to use “portability” (which is an estate tax election used to preserve the estate tax benefits or credit amount attributable to the deceased spouse), a qualified disclaimer and a spousal trust can also be used to preserve those tax benefits. If a governing instrument provides both of these tax planning procedures to a surviving spouse, it is best to review the pros and cons of each tax planning mechanism.
A donee may want to consider making a disclaimer for creditor protection purposes. For example, if there is a properly drafted governing instrument that provides for disclaimed property to be held in a marital or spousal trust, and the surviving spouse exercises the disclaimer, the property disclaimed may avoid the creditor claims of the surviving spouse. Even in the absence of a marital or spousal trust, a disclaimer may be used to offload assets to the deceased spouse’s other family members if the original donee has creditors ready to jump at the assets. Under Maryland law, a disclaimer, if made for creditor purposes, does not need to be made within the nine-month window (which is imposed by federal regulations). It only need be made before the disclaimant receives a benefit from the property.
Disclaimers can be useful for post-mortem planning, whether for tax-focused or creditor protection focused planning. It is another planning tool that can be used during the admistration of an estate or trust.
For over 35 years, the law firm of Franke Beckett LLC has concentrated on the law of estates and trusts – including helping hundreds of clients with estate and trust administration. Sophisticated estate planning documents may provide that a disclaimer be used to deflect assets into a trust instead of outright to a surviving spouse. Whether to use the disclaimer mechanism is not an automatic decision but one that requires thought and consideration. Our Maryland estate administration attorneys and staff have the experience, training and knowledge to guide clients through the process of making such a decision as well as to generally ensure that Maryland estates and trusts are administered properly. To schedule a consultation, call 410-263-4876 to get in touch with our Annapolis office.