Disclaimers - Saying "No" to Your Inheritance

The New York Times ran an article this week "Saying ‘No Thanks’ to a Bequest".  In the article, Deborah L. Jacobs explores how a disclaimer provision either included in an estate plan, or created after death, can achieve some estate tax savings in this environment of uncertainty about the federal estate tax this year or next.

In an estate plan a "Disclaimer" is when a beneficiary says "No, I don't want that part of my inheritance."  Now, why would a person not want an inheritance?  Well, for a spouse, a disclaimer is used more accurately to say "I don't want to take my inheritance outright, and therefore it should pass to a trust where I am a beneficiary." This trust could capture the exemption amount from federal estate taxes if and when the federal estate tax comes back.  A disclaimer creates flexibility in a period of uncertainty as the spouse doesn't have to decide now if it makes sense to fund the trust, they can wait and see what the tax laws are at the time the first spouse dies.

The article outlines how a disclaimer works, the benefits of disclaimers (flexibility being key) and some of the drawbacks (what if the spouse doesn't disclaim, or accepts the assets so they can't disclaim).  However, I think the article misses one key point about how using disclaimers to create trust can create inflexibility.  If a person sets up a trust in their Will and directs that it be funded (i.e.: put $1 million is this trust) instead of allowing it to be funded through a disclaimer (i.e.: I spouse disclaim $1 million which will now pass to a trust), then the trust can give a person a "Power of Appointment" over the trust.  

A "Power of Appointment" essentially allows a person to change who gets the trust funds and how after the death of the decedent.  This is incredibly powerful in using a trust.  A trust will last for years or decades after your death.  Unless you have a crystal ball, you don't know what will happen to your beneficiaries, or what the tax laws will be in the future.  By setting up a trust for your spouse and children, and giving your spouse a Power of Appointment, your spouse has the ability to change how your children eventually get your assets after your spouses' death.  For example, if a child has a health issue, your spouse can change the trust to leave more to that child, or to leave it to the child in trust instead of outright.  Without the Power of Appointment the child might get money that would negate other benefits he was receiving.

So how to balance the flexibility of a disclaimer with the flexibility of a Power of Appointment? In New Jersey, where we have a state level estate tax of $675,000, we recommend a "3-Part Will".

  • Part 1 - An amount equal to $675,000 goes to a family trust with a power of appointment in favor of the surviving spouse
  • Part 2 - An amount equal to the difference between (1) the federal estate tax exemption amount (if any) and $675,000 go to the spouse - the spouse can disclaim this amount to a family trust if it makes sense from an estate tax perspective
  • Part 3 - The balance to the spouse  

 

No Estate Tax in 2010 - What Opportunities Might there be?

 My two prior posts have been about the  federal tax impact for single individuals who die in 2010, and the federal tax impact for married individuals.  In summary the results for singles were not good, and for marrieds were worse – the "death" of the estate tax creates a capital gains "trap" for survivors.  While all this will be moot if Congress does as they have promised and create an estate tax retroactive to January 1, 2010, they haven’t acted yet, and as of January 1, this is the law.

What planning can be done in this environment?

Can you just say “whoo-hoo”; I’ll give everything to my children.  Hold on there – the federal estate tax is repealed in 2010, not the federal gift tax.  Each person still has a lifetime exemption of $1,000,000 – if you make gifts in excess of that in 2010, you will be subject to the federal gift tax at a rate of 35%.

However, the generation skipping tax (“GST tax”) is repealed in 2010.  The GST Tax essentially says that you can only leave up to $3.5 million to grandchildren without paying a separate tax of 55%.  The theory behind the GST Tax is that the government should share in the wealth at each generation.  If grandma leaves everything to granddaughter, the IRS might need to wait 75 years until tax can be collected again.  If assets go the children, the IRS might only have to wait 30 years to tax again.  So, in 2009 you could leave up to $3.5 million to grandchildren without GST tax. In 2010, you can leave everything to grandchildren without an additional tax.  For wealthy families, this could mean a huge amount passing to lineal descendants with the only tax cost(s) being capital gains (click here for an explanation of the 2010 capital gains tax trap for estates).

The estate plan you had in 2009 and will need again in 2011 won’t really make sense in 2010 unless they make the estate tax retroactive.  Do you need to go out and totally revise your plan? Not necessarily.  If you have a terminal situation however, it definitely bears looking at your current plan to make sure it addresses how to plan to minimize capital gains taxes instead of estate taxes.

Gifts to grandchildren may be a winning strategy in early 2010.  Also, for anyone who is terminally ill, a change of an estate plan to leave assets to grandchildren may be a winner as well (although if the estate plan isn’t changed, disclaimers may be able to be employed by the children to a similar effect).  And it will bear looking at the estate plan of anyone who is terminally ill.

 

Image: Danilo Rizzuti / FreeDigitalPhotos.net

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