A Bit More on Disclaimers
As I discussed yesterday, disclaimers are a way of saying "thanks but no thanks" to a gift of property. They are usually used in connection with gifts made at death, in one of two scenarios:
1. The tainted property scenario. The situation in yesterday's post would qualify here -- if you are given property that may be subject to litigation or is otherwise encumbered, you may not want to accept it.
2. The estate or gift tax scenario. This is a more common situation, where you either don't want to increase the size of your estate by accepting an inheritance or you want to (in a sense) steer an inheritance to someone who may need it more. Let me give a couple of examples:
Ex. 1: Mildred Smith, a widow, dies at age 80. Mrs. Smith is survived by her son, Kenneth, who is an investment banker. Mrs. Smith's Will leaves all of her estate ($1.5 million) to Kenneth or, if he doesn't survive her, to Kenneth's three children. Kenneth already has a net worth of $3 million, and he doesn't need any more property; however, his children are all in their mid-to-late 20's, and are trying to establish themselves. If Kenneth accepts his gift under his mother's Will, and then passes it on to his three children, he will owe gift tax. However, Kenneth instead disclaims his gift under his mother's Will -- the gift automatically passes to Kenneth's three children as if Kenneth predeceased his mother, and no gift tax is due.
Ex. 2: Bob Jones, a married man with three children (ages 22, 20 and 18), dies without a Will in 2005 (when the estate tax exemption is $1.5 million). Under Illinois law, his $5 million estate will pass one-half to his wife and one-half to his three children, which isn't what Mr. Jones would have wanted; to add insult to injury, because a significant amount of his estate will pass to beneficiaries other than his wife (and therefore won't qualify for the marital deduction), an estate tax will be due. Mr. Jones' children each disclaim all but $500,000 of their inheritance, thereby giving more of Mr. Jones' estate to his wife (their mother) and eliminating any estate tax due (since the sum total of their inheritances equals the amount of the estate tax exemption).
Using a disclaimer to deal with estate tax issues is sometimes described as "post-mortem estate planning" -- that is, you use a disclaimer to create the estate plan the decedent should have executed during his or her life. This can work very well, so long as you don't run afoul of the many rules relating to disclaimers. Essentially, we're talking about:
State property law. In Illinois, the main rules are found in §2-7 of the Illinois Probate Act (the Disclaimer Under Nontestamentary Instrument Act, at 760 ILCS 25, is also relevant for trusts). Section 2-7 discusses (among other things) (1) how the representative of a deceased or disabled person or a minor can disclaim on their behalf; (2) the form of the disclaimer; and (3) actions by the person seeking to disclaim that might bar such person from disclaiming property successfully.
Federal Tax law. The key section of the Internal Revenue Code that discusses disclaimers is §2518.
A few final points:
- In my experience, the biggest impediment to a successful disclaimer is "grabby hands." In Illinois, you can't disclaim property after you have accepted it. So, for instance, if you are a surviving spouse, and immediately start making withdrawals from your deceased wife or husband's bank accounts after her or his death, you will probably be barred if you subsequently try to disclaim these accounts.
- While I talk above about "steering" property to other beneficiaries, this can't be done directly. In other words, you can't direct where the disclaimed property should pass.
- Disclaiming inherited property in order to avoid creditors or to qualify for Medicaid is an increasingly complicated business, and may not be possible.
It may sound like self-interest, but I think the key to dealing with disclaimers is to talk with a probate attorney as soon as possible after a loved one passes away.
