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Be Careful Making Disclaimers Where Trusts Are Involved

New letter ruling highlights how tricky it can be to meet the fourth requirement for a qualified disclaimer when disclaimed property passes to a trust.

February 2009
by Justin Ransome/The Tax Adviser

Disclaimers are very useful tools for estate planners, especially in postmortem planning. Disclaimers allow interests in property to pass to parties other than the original object of a donation or bequest. In postmortem planning, a disclaimer is often used to qualify an interest for an estate tax deduction (e.g., marital or charitable) or to more efficiently use a decedent's estate tax applicable credit amount or generation skipping transfer (GST) exemption amount. However, if an estate planner is not diligent in the planning and execution of a disclaimer, it can have adverse transfer tax consequences.

Disclaimers are governed by both state and federal law. State law disclaimers determine how property interests pass to other parties as the result of a disclaimer. Under many states' disclaimer laws, if the requirements of a disclaimer are met, disclaimed property interests flow as if the disclaimant had predeceased the donor or decedent.

Under federal tax law, if a person makes a "qualified disclaimer" with respect to an interest in property under Sec. 2518, the disclaimed interest is treated for gift, estate, and GST tax purposes as if the interest had never been transferred to that person. Thus, if a person makes a qualified disclaimer, that person will not incur transfer tax consequences as a result of the qualified disclaimer because he or she is disregarded for transfer tax purposes.

Note, however, that unlike many states' disclaimer laws, the federal law does not treat the disclaimant as if he or she had predeceased the decedent. Sec. 2518 provides that a qualified disclaimer is an irrevocable and unqualified refusal by a person to accept an interest in property, but only if: (1) the disclaimer is in writing; (2) the disclaimer is received by the transferor of the interest, his or her legal representative, or the holder of the legal title to the property to which the interest relates not later than nine months after the later of (a) the date on which the transfer creating the interest in the person is made or (b) the day on which the person attains age 21; (3) the person has not accepted the interest or any of its benefits; and (4) as a result of the disclaimer, the interest passes without any direction on the part of the person making the disclaimer and passes either to the decedent's spouse or to a person other than the person making the disclaimer.

Assuming an estate planner is aware of the requirements, he or she should not have difficulty in executing a qualified disclaimer. However, a recent Tax Court case and a recent letter ruling highlight how tricky it can be to meet the fourth requirement for a qualified disclaimer when disclaimed property passes to a trust, and the negative tax consequences that may occur if the requirements of a qualified disclaimer are not met.

This article has been excerpted from The Tax Adviser. Read the full article here (PDF).