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Using Disclaimers in Estate Planning & Administration

Using Disclaimers in Estate Planning & Administration

Posted on October 16, 2020

Before advising a client to make a disclaimer, practitioners should carefully consider all of the potential ramifications.

Author: Jeffery D. Scibetta

Originally published in October 2020

This article has not been updated for current law since the date of its posting on the website. This article is not intended to provide any legal advice. Please seek advice of your professional council.

Any U.S. federal and state tax advice contained in this communication is not intended or written by the Knox Law Firm to be used, and cannot be used by you, for the purpose of: (i) avoiding penalties under the Internal Revenue Code that may be imposed upon you, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Overview

Definition of Disclaimer
How Disclaimers Can Be Useful
Complexities of Disclaimers

What Is a Disclaimer?

A disclaimer is an affirmative refusal to accept an interest in property that would otherwise be received, whether during lifetime (by way of gift) or at death (through an inheritance or bequest).

Elements of a Gift. To better understand the notion of a disclaimer, it may help to consider that the elements of a gift are (1) donative intent, (2) delivery of the gifted item, and (3) acceptance of that item. Although the requirements are ordinarily considered in the context of a lifetime gift, the same elements are arguably present in any gift, whether made during lifetime or at death. A disclaimer can therefore be thought of as an action on the part of the would-be recipient that negates the existence/occurrence of the third requirement listed above (acceptance), thereby nullifying the gift from a legal standpoint.

Effect of Disclaimer (Generally). If the disclaimer is effective, the disclaimed property is considered not to have ever been gifted to the donee, and therefore the property is treated as still belonging to the donor (if there are no alternate takers) or as passing directly from the donor to whomever was next-in-line to receive it (where there are alternate takers).

Disclaimer as a Legal Tool. Disclaimers can serve as a tool for estate planners in circumstances where a recipient of property prefers not to receive the property given to him.

Not a Panacea. Although disclaimers are tactically an important “arrow in the quiver” of estate planners, they are nevertheless, not an all-purpose solution to problems in estate planning. Before advising a client to make a disclaimer, practitioners should carefully consider all of the potential ramifications.

How Disclaimers Can Be Useful

Pre-Death Disclaimer Planning. Disclaimers are often part of estate planning both before and after a decedent’s death. Pre-death disclaimer planning is typically intended to add flexibility to an individual’s estate plan to allow for unknown future circumstances. Pre-death planning typically involves drafting estate plan documents that allow for the exercise (use) of the disclaimers after the individual’s death.

Examples. Examples of “pre-death” disclaimer planning include:

Disclaimer trust provisions in a Will, i.e., Will provisions that stipulate that disclaimed assets pass into a testamentary trust, typically for the benefit of the surviving spouse and children; and
Secondary beneficiary designations for beneficiary designated accounts (such as company retirement plan accounts, IRAs, annuities and/or life insurance policies).

Post-Death Disclaimer Planning (a/k/a “post-mortem” planning). Disclaimers are also frequently utilized in planning related to a decedent’s estate administration. This type of “after-death” planning (also referred to as “post-mortem” estate planning) is typically when the disclaimers are made. Disclaimers are often used in a post-mortem estate context in order to accomplish different goals, including:

Fixing problems in a decedent’s estate plan; and/or
Addressing circumstances that may have changed since the time the decedent’s estate plan was drafted but which were not necessarily knowable at that time, such as:
Changes in the law;
Changes in the decedent’s circumstances; or
Changes in beneficiaries’ circumstances.

Complexities of Disclaimers

In General. Disclaimer planning can be complex for various reasons, including the following:

It requires an understanding of a number of complicated areas of law; and
The consequences of making a disclaimer are not always obvious.

Importance of Understanding the Ramifications of Disclaimers. It is critically important that practitioners and clients understand the issues and ramifications related to the use of disclaimers. Although disclaimers can be successfully used to minimize or even eliminate various problems related to an estate administration, that is certainly not always the case.

Furthermore, if a disclaimer is unsuccessfully attempted or is made inadvisably, it can have serious (and possibly unforeseen) consequences, and it can sometimes make a situation worse rather than better.

Applicable Laws. Disclaimer planning can potentially involve a number of different areas of state and federal law, including

State laws governing the transfer of property;
State laws governing the administration of estates and trusts;
Federal and State death tax laws, such as
Federal estate and gift tax;
State inheritance tax; and
GST tax
Federal and State Disclaimer Requirements. It is therefore important to understand that there are requirements for an effective disclaimer under most states’ property laws that are separate and apart from those requirements that must be met in order for a disclaimer to be effective for tax purposes.

What happens if the requirements for a disclaimer are not met?

Failure to Meet the State Property Law Requirements. – If the state property law requirements for an effective disclaimer are not met, then the disclaimer will, by definition, not be effective and the disclaimant will generally be treated as having received (and thus as now owning) the disclaimed asset.

Failure to Meet the Tax Law Requirements. – If the requirements for an effective disclaimer under federal or state tax law are not met, then a disclaimant will be treated for tax purposes as having received the disclaimed assets and then transferred the disclaimed asset to the eventual recipient. However, that does not necessarily mean that the disclaimant will be the legal owner of the assets that they unsuccessfully attempted to disclaim. If the property law requirements (but not the tax law requirements) for an effective disclaimer are met, then the disclaimant could be treated as having made a transfer of the asset for tax purposes, even though they in fact still owns it – an anomalous circumstance which many clients probably would not even understand let alone anticipate.

Importance of Disclaimer Requirements. So as a practical matter, if the use of a disclaimer is intended primarily to accomplish a tax objective (as is commonly though not always the case), then it will be necessary to meet the state substantive law requirements as well as any additional tax law requirements for making an effective disclaimer.

Critical Issues. Before making a disclaimer, an individual should always consider three very important issues:

Issue #1: What requirements must be met in order for the disclaimer to be effective?
Issue #2: What happens if those requirements are not met?
Who gets the disclaimed asset?
What are the tax ramifications?
Issue #3: If the disclaimer is effective, then what happens?
Who gets the property?
What are the tax ramifications?

Types of Interests That Can Be Disclaimed

Who can make a disclaimer?

“By whatever means.” The applicable statutory law in Pennsylvania states that a disclaimer can be made by “[a] person to whom an interest in property would have devolved by whatever means …” (

20 Pa.C.S. §6201) (Emphasis added.) Based on the quoted language (“by whatever means”), the intent on the part of the legislators appears to have been to make disclaimers broadly available to a wide array of potential recipients.

Examples of Disclaimants. The statute goes on to list, by way of example, the following persons as entitled to make a disclaimer:

A donee of a lifetime transfer (i.e., a lifetime gift);
A beneficiary under a Will;
An heir through intestacy;
A joint tenant with right of survivorship (i.e., surviving joint owner);
A beneficiary of a “third party beneficiary contract” (including beneficiaries of life insurance and annuity policies and pension, profit-sharing and other employee benefit plans);
An appointee under the exercise of a power of appointment; and
A person entitled to a disclaimed interest

Disclaimers by Fiduciaries on Behalf of Others. Disclaimers are typically made by the person(s) who would otherwise benefit from the interest being disclaimed, as noted above. However, disclaimers can also be made in certain circumstances on behalf of other persons, including:

By a guardian of a minor’s estate (on behalf of the minor);
By an agent under power of attorney on behalf of an incapacitated person (if the power of attorney expressly authorizes the making of a disclaimer on behalf of the principal); and
By an executor on behalf of an estate.

Generally, a disclaimer made on behalf of another person (including those under the circumstances listed above) requires court approval in order to ensure that the disclaimer does not materially prejudice the rights of the persons on whose behalf the disclaimer is made or their creditors. However, an executor can make a disclaimer on behalf of an estate without court approval if the decedent’s Will expressly authorizes the executor to do so.

Interests Subject to Disclaimer

Transfers during Lifetime. As previously noted, many different types of interests in (or powers over) property may be disclaimed, including interests (or powers) conveyed during the donor’s lifetime and at death. Lifetime transfers would include those made outright and free of trust (such as a gift or money or property to a particular person) and those made in trust.

Transfers at Death. Disclaimable testamentary interests include:

Bequests or devises under a Will;
Interests in an intestate estate; and
Interests obtained by operation of law, such as
Survivorship interests in a jointly owned asset;
Beneficiary interests in beneficiary designated accounts/policies, such as (1) a company retirement account; (2) an IRA; (3) an annuity policy; or (4) an insurance policy.

How Much can be Disclaimed?

“In Whole or in Part”. The Pennsylvania disclaimer statute specifically states that the party making a disclaimer can make that disclaimer “in whole or in part.” So, as in most states, Pennsylvania law allows for complete or partial disclaimers. Stated differently, a person can disclaim all interest or only part of their interest in the subject property (20 Pa.C.S. §6201).

Although the tax laws typically also allow for the making of a complete or partial disclaimer, they often set forth more detailed requirements that must be met in order for a partial disclaimer to be effective. That is particularly the case for federal estate and gift tax.

Requirements For an Effective Disclaimer

Full requirements for an effective disclaimer can be found in Pennsylvania Estate and Trust Law [20 Pa.C.S. §6201 et seq.]

Generally, the Pennsylvania Estate and Trust Law Requirements for a Disclaimer include the following:

A written document;
Containing language disclaiming an interest in (or power over) property;
Adequately describing the property interest at issue and the portion being disclaimed;
Signed by the disclaimant;
Delivered to the appropriate parties;
Filed at the appropriate office of the courthouse (under certain circumstances); and
Without any prior acceptance of the property interest or any of the benefits related to it.

Potential Planning Opportunities: When a Disclaimer Could Be Useful

Example #1: Cleaning up an un-planned (intestate) estate

The Facts:

Decedent dies unexpectedly and without a Will.
Decedent is survived by his wife who was a stay-at-home mom and by one child, a son who is a young adult and has a very good job.
Under the PA intestacy statute, the decedent’s first $30,000 would go to mom and then the balance of the estate would be split evenly between mom and the son.

The Problem: Mom really needs more than just one-half (1/2) of the estate to live on, and son recognizes that, and agrees that the decedent would have wanted everything to go to his surviving spouse if he had gone to the trouble of having a Will prepared.

Possible Solution: Son could disclaim all or a part of his inheritance from dad in order to provide for mom.

Advantages:

Mom has more of the estate and is therefore better off.
PA inheritance tax is saved on the disclaimed amount.
Federal estate tax marital deduction is increased.
There are no gift or estate tax consequences to mom.

Potential Issues:

What if the decedent’s children are minors?
What if the decedent’s children have children/descendants?

Example #2: Fixing a poorly planned state (Spouse gets too much)

The Facts:

Decedent has a simple Will.
100% of estate bequeathed to decedent’s spouse, if living.
Otherwise, the estate passes equally to decedent’s children.
Decedent dies, and is survived by spouse and children.
After the decedent’s death, the spouse decides that it would have been better if the decedent had given some portion of the decedent’s estate to the decedent’s children.

The Problem: Reasons why a Spouse might want less than all of the assets

Second Marriage / Blended Family – where a decedent overlooked needs/desires of their children from the earlier marriage and gives their entire estate to newly married spouse. The spouse might want to “do right” by the spouse and/or the children, or to appease the family members who were left out and avoid a messy situation.
Family Business – where the spouse thinks that an ownership interest in the family business might be better directed to one of their children who is actively involved in the running of the business.
Needy Children – where the children are considerably less well off than the spouse.

Possible Solution: If the spouse files a disclaimer, then the disclaimed assets could pass under the terms of the Will to the decedent’s children.

In the case of a blended family, the surviving spouse can disclaim those assets that should’ve been left to the decedent’s children.
In the case of a family business, the surviving spouse can specifically disclaim the ownership interest in the family business that should’ve gone to the child who is actively involved in the running of the business.
In the case of the needy children, the surviving spouse can disclaim whatever she thinks is necessary to more adequately provide for the needs of the children.

Example #3: Keeping Things Equal between the Sisters

The Facts:

Mom, a widow, has two adult daughters.
One of the daughters (“T”) went through some troubled times when she was younger and was estranged for a period of time.
The other daughter (“O”) has always been on good terms with mom.
However, Mom has been on good terms with both daughters for the last several years.
Mom’s Will therefore provides equally for each of her daughters.
Mom’s main asset is an IRA, which she has not updated in many years.
Under the most recent (but still very old) beneficiary designation, Mom’s IRA goes entirely to one daughter, O.

The Problem:

The one daughter (T) is excluded from getting any part of Mom’s IRA, which may could potentially strain relations between the two daughters.

The Solution:

Daughter O who is the IRA beneficiary disclaims one-half (1/2) of her interest in the IRA balance by filing a disclaimer with the IRA administrator/custodian.
Because Mom never designated a contingent beneficiary, the disclaimed half of the IRA balance defaults to Mom’s estate.
Under the terms of Mom’s Will, the two daughters (T & O ) each get and equal share of th
So Daughter O must also file a second disclaimer with the Executor of Mom’s estate in which O disclaims any interest in the IRA proceeds paid to the estate.
When all is said and done, the sisters have shared the IRA equally – O gets one-half (1/2) of the IRA balance directly and T gets the other one-half (1/2) of the IRA balance through her interest as an estate beneficiary.

Example #4: Terminating an Unwanted Trust

The Facts:

Dad during his lifetime created an insurance trust for the benefit of Mom and their three adult children.
The trust holds a relatively modest ($150,000) “first-to-die” life insurance policy on Dad’s life.
Dad dies and the insurance policy proceeds are paid to the trust.
The trust agreement provides as follows:
While Mom is living, all of the trust net income must be distributed to Mom.
At Mom’s death, the trust terminates and any remaining trust assets must be distributed to the children

The Problem:

Mom already has sufficient funds and therefore does not need anything from the trust.
The children would prefer to have the trust money in hand to help them pay for the costs of raising their own (minor) children.
Neither Mom nor the children want to incur the time and expense of administering a trust during Mom’s lifetime.

The Solution:

Mom disclaims all of her lifetime interest in the trust;
Since Mom no longer has any interest in the trust assets, the trustee can distribute the trust assets to the children.

Example #5: Saving the Marital Deduction (Part I)

The Facts:

Decedent (“D”) is survived by his wife (“W”) and his 2 children.
D’s Will provides that entire estate passes into a testamentary trust.
The trust provisions in the Will state that:
All of the trust income is annually distributed to the wife for the rest of her life;
During wife’s lifetime, the Trustee is also permitted to “sprinkle” (i.e., distribute) the trust principal to the wife or to any of the children as needed for their “health, education, maintenance and support”; and
When W dies, any principal remaining in the Trust at that time will be distributed in equal shares to the children.

The Problem:

The Trust does not currently qualify for the Marital Deduction because W is not guaranteed to annually receive all of the trust’s net income.
Why? Because the trustee is permitted to distribute the principal to persons other than W (i.e., the children) during W’s lifetime.

The Solution:

The children disclaim any and all rights to (or interest) in the trust principal during W’s lifetime.
Since whatever rights the children have in the principal is at the trustee’s discretion, the trustee should also disclaim any discretionary authority to distribute principal to the children during W’s lifetime.
Following the disclaimer, the executor of D’s estate could make a QTIP election on behalf of the estate to qualify for the marital deduction.

Example #6: Saving the Marital Deduction (Part II)

The Facts:

Decedent (“D”) is survived by his wife (“W”) and his 2 children.
D’s Will provides that his entire estate passes into a testamentary trust.
The trust provisions in the Will state that:
All of the trust income is annually distributed to the wife for the rest of her life;
Instead of the trustee having authority to “sprinkle” trust principal to other persons, W is instead given the power to appoint trust principal in favor of the children during her lifetime if she sees fit; and
When W dies, any principal remaining in the Trust at that time will be distributed in equal shares to the children.

The Problem:

The Trust does not currently qualify for the Marital Deduction because W is not guaranteed to annually receive all of the trust’s net income.
Why NOT? Because W has the ability, through the exercise of her power of appointment, to cut off her own right to annually receive the trust income.

The Solution:

W disclaims her power of appointment in favor of the children under the Will.
The disclaimer enables the executor to elect “QTIP” treatment and qualify for the marital deduction.

Example #7: Unanticipated Collateral Beneficiaries

The Facts:

Decedent (“D”) died unmarried and without children.
D’s only survivors were his sister (“S”) and her children.
D designated S as the primary beneficiary of his Will.
The Will said that all death taxes are to be paid out of the estate.
But D had previously purchased a large annuity many years ago and at that time he designated one of his nieces (“N”) as the primary beneficiary of the annuity.
Because D never updated the beneficiary designations, N was still listed as the primary beneficiary of the annuity at the time of D’s death, and so she inherits the annuity.

The Problem(s):

Because D never bothered to update the beneficiary designation, a significant part of D’s wealth does not go to the beneficiary to whom D probably intended it go at his death.
Also, the inheritance tax rate applicable to a niece (15%) is slightly higher than for a sibling (12%).
To make matters worse, because of the way the Will was written, the inheritance tax on the annuity has to be paid by S rather than by N.

The Solution:

N disclaims her interest as designated beneficiary in the annuity.
The annuity would then pass to the designated beneficiary who is next-in-line.
If S is the designated contingent beneficiary, then problem solved!
Even if no contingent beneficiary is named, if the annuity defaults to D’s estate (as commonly happens), then S would ultimately succeed to the annuity proceeds as the primary beneficiary of the estate.

Example #8: Avoiding a Radioactive Inheritance

The Facts:

Decedent (“D”) dies owning land that had been used a toxic waste dump.
The property is under investigation by the Department of Environmental Protection (“DEP”,) and there is strong reason to believe that there may be substantial environmental liability to any owners.

The Problem:

The beneficiaries of D’s estate are all already well off and they’re all very concerned about whatever legal exposure might result from owning the property.

Potential Solution:

The beneficiaries might want to consider disclaiming any interest in the property in order to avoid or minimize potential environmental liability associated with the land.

Example #9: Successive Deaths

The Facts:

Husband (“H”) and Wife (“W”) die in relatively short order – H dies first and then within W dies within a matter of months afterward.
Each of their Wills provides that all assets pass first to the spouse (if living) and then to the children.
Almost all of the assets were titled in H’s name.

The Problem:

Even though the assets will ultimately pass to the intended parties, administering two estates in short succession will incur additional administrative costs.

Potential Solution:

The solution could be to have W’s Executor disclaim any interest on behalf of W’s estate in any of H’s assets.
If all of the assets pass directly to the children out of H’s estate, it may not be necessary to administer W’s estate

Situations When Disclaimers Do Not (Or May Not) Work

Debts Owed to the Government

Money Owed to IRS. If an individual makes a disclaimer for the purpose of avoiding an obligation to the federal government, they are unlikely to be successful. The issue has arisen in a number of instances where a taxpayer owed money to the Internal Revenue Service (“IRS”) and was encumbered by a federal tax lien. The taxpayer is the beneficiary of an estate but, in an effort to avoid paying the government, disclaims their inheritance. Although there have been some cases where courts have ruled to the contrary (See, e.g., Leggett Estate v. U.S. 97-2 USTC ¶60,286 (5^th Cir. 1997); Mapes v. U.S. 15 F.3d 138 (9^th Cir. 1994)), the clear issue appears to have been resolved in the government’s favor (Drye v. U.S. 120 S. Ct. 474 (1999); see also Tanari v. U.S. 78 AFTR 2d 96-2, ¶50,460 (E.D. PA. 1996)).

For planning purposes, employing a disclaimer to avoid paying a federal government obligation, such as a tax lien, is therefore a seemingly dubious proposition.

Disclaimer to Avoid Medicaid Obligations. Another strategy that is unlikely to prove successful is to disclaim assets in an attempt to become (or remain eligible for Medicaid). Prior to 1993, there was some question as to whether a disclaimer would be counted as a disqualifying transfer for Medicaid purposes. However, in 1993, Congress broadened the definition of a “transfer” for Medicaid to include disclaimers as a disqualifying transfer (42 U.S.C. §1396p(c)). According, if a Medicaid applicant disclaims assets within the pertinent five year “look-back” period, the disclaimer will cause the applicant to be ineligible for Medicaid for a period of time.

Debts Owed to Creditors (Other than the Government)

Bankrupt/Insolvent Beneficiary. If the disclaimant’s obligation is not to the government but instead owed to private individuals, then the answer is less clear cut. The pertinent Pennsylvania statute states that “[n]othing in this section shall determine the effect of a disclaimer upon rights of creditors of the disclaimant.” (20 Pa.C.S.A. §6205(d)). However, in at least one Pennsylvania appellate court case, the court set aside a disclaimer for the benefit of creditors where the disclaimant was insolvent at the time of the decedent’s death (Gallagher v. Riddle, 850 A.2d 748 (Pa. Super 2004)). The issue would most likely be framed as whether the disclaimer should be viewed as a “transfer” for the purpose of the state fraudulent conveyance law. Although the issue has not been definitely resolved as of this writing, it would seem reasonable to argue that a disclaimer should be so construed, particularly if the disclaimant is insolvent at the time the disclaimer is made. Accordingly, from a planning standpoint, the safest course may be to avoid the use of a disclaimer in an insolvency or bankruptcy context.

Solvent Beneficiary. If the disclaimant is insolvent or bankrupt, the chance of success is presumably better, although the issue has not yet been directly addressed. The outcome might depend on the particular facts involved. For example, if the disclaimant was not already insolvent when the disclaimer was made, how solvent was he at that time? Did he ultimately become insolvent? If he ultimately became insolvent, how years or months was it after he made the disclaimer?

How Disclaimers Can Fail

In General

Not a Panacea. Disclaimers are often utilized in post-mortem planning to meet any number of different objectives. While disclaimers can be a useful tool in an advisor’s planning arsenal, they are not appropriate in all situations and cannot fix each and every problem a practitioner encounters.
Adverse Outcomes. If a disclaimer is made in a way that fails to satisfy all of the applicable requirements or if a disclaimer is made under circumstances where it is unwarranted or inadvisable, then it can potentially create problems where none existed or can make an existing problem worse.

Failure to Meet Requirements

Failing to achieve a Federal Tax Requirements. As just noted, disclaimer may not be successful because it was made in a way that fails to meet all of the applicable requirements. That is particularly true when a disclaimer is filed with a specific tax-related objective in mind. Disclaimers are often strategically used in federal estate and gift tax planning to achieve a desired end. If the disclaimer fails to meet the requirements for a disclaimer under federal tax law, it more than likely will fail to meet the desired objective.

Disclaimer made to qualify for the Marital Deduction. As just noted, disclaimers are often utilized in a post-mortem context to meet various objectives. A commonly sought objective in federal estate tax planning is to qualify for (or increase) a marital deduction. One situation where the issue can arise is when a decedent bequeaths assets to a trust that is intended to benefit a surviving spouse (a “marital trust”) but which does not meet all of the requirements for the marital deduction. Under such circumstances, a disclaimer can sometimes be used to cure one or more of the trust’s defects and thereby qualify it for the marital deduction. However, that goal will typically not be met if the disclaimer does not itself meet all of the federal tax requirements for a Qualifying Disclaimer.

Example: Husband (“H”) dies in 2020. H’s Will bequeaths his entire estate to W as trustee of a testamentary trust intended to primarily benefit his wife (“W”) during her lifetime and to also qualify for the Marital Deduction for federal estate tax purposes. Under the terms of the trust (as set forth in H’s Will), all trust income is distributable each year to W as the surviving spouse throughout her lifetime, but the trustee is also authorized to distribute trust principal to W or to any of their children.

Because of the Trustee’s authority to distribute trust principal to persons other than W, the trust does not qualify as a “QTIP” trust (i.e., a trust eligible for the Marital Deduction).

W therefore disclaims her right as trustee to distribute principal to the children in the hope of qualifying the trust for the Marital Deduction. However, a successor trustee would still have that same power, and so the disclaimer does not effectively extinguish the power. Only a disclaimer by the children (as permissible beneficiaries of the fiduciary power) would qualify the trust for the Marital Deduction (See TAM 8729002).

Example: Husband (“H”) dies in 2020. H’s Will bequeaths his residuary estate to his wife (“W”). The Will further provides that any assets disclaimed by W pass into a testamentary trust that benefits W during her lifetime. Under the trust terms (as set forth in the Will), all trust income is required to be distributed each year to W and the trust principal may be distributed at the trustee’s discretion to W as needed for her health, education, maintenance or support. W is also given a testamentary power to appoint any remaining trust assets (at the time of her death) in favor of any of her children. Any un-appointed trust assets pass in equal shares to the children.

W disclaims the residue which then passes into the trust. W retains her power to appoint the trust assets at her death. Because W retains the power to appoint the trust assets, the disclaimed assets do not pass “without direction” by the disclaimant (i.e. W). The disclaimer is therefore not a Qualified Disclaimer. Because the disclaimer is not qualified, the disclaimed assets are not treated as passing directly from H into the trust that could qualify for the Marital Deduction.

Failing to Meet State Tax Requirements. Disclaimers are also commonly used to meet tax planning objectives at the state level as well. If a disclaimer fails to meet applicable state tax requirements, the disclaimer more than likely not meet the desired objective.

Example: H is survived by his wife, W and by 2 children, S and D. H dies without a Will and so his estate passes under the intestacy statute in roughly equal shares to W and to the children (with spouse getting one-half and the children getting the other half). (Assume for the purpose of this example that S and D do not have any children of their own.)

S and D do not need their inheritance, and would just as soon see their shares go to their mother. They also prefer not to have to pay PA inheritance tax. So S and D both disclaim their shares of H’s estate with the intent that those shares pass to W. (Assume that S and D both do not have any children of their own.)

However, S and D fail to make their disclaimers within nine (9) months of H’s death. Their disclaimers are therefore effective for PA property law purposes but not for PA Inheritance Tax purposes. Therefore, the disclaimed shares of the estate will be treated for PA tax purposes as passing first to S and D and then to W. Accordingly, S’s and D’s objective of avoiding PA Inheritance Tax is not met.

Failing to Understand the Ramifications of the Disclaimer – May Result in Passing Disclaimed Assets to Unintended Persons

Another way that a disclaimer can “fail” is if the disclaimant fails to fully take into account all the relevant ramifications of making the disclaimant. If a disclaimer was not the correct “tool” to use in the first place, then the fact that all of the specific requirements may have been met will be “cold comfort” to the advisor who recommended that course of action.

Importance of Knowing Ultimate Recipient. One of the most important things to understand before making a disclaimer is where the disclaimed assets will ultimately pass. Put simply, if the disclaimant does not get the disclaimed assets, then who is next-in-line to receive them? If an individual makes a disclaimer without knowing the answer to that question, disastrous consequences can ensue.

Example: H dies intestate, and is survived by his wife, W, and his two children, S (his son) and D (his daughter). Assume that S and D each have two children of their own. The grandchildren are all minors.

Because H died without a Will, his estate passes in accordance in the manner set forth in the intestacy statute.
Under the Pennsylvania intestacy statute, the first $30,000 goes to W, and then she gets one-half (1/2) of the remaining assets.
S and D are both financially secure and they want their mother to have more to live on than she was given by their father.
So S and D both disclaim their respective shares of H’s estate, with the intent that those disclaimed shares will pass to W.
However, the intestacy statute states that the share of the estate not passing to the spouse (W) passes to the decedent’s “descendants.”
So by making the disclaimers, S and D effectively passed their shares of the estate on to their own children (the grandchildren) rather than to their mother.
In this example, the disclaimers clearly made the problem worse!

Example: Decedent (“D”) bequeaths assets all of his assets to his (second) wife (“W”), who is not the mother of his three (3) children (A, B & C). In order to provide something for his children, D designated each of them (A, B & C) as equal beneficiaries of an insurance policy on his life.

A is already much more financially secure than his siblings, and therefore wants to help B & C. So A disclaims his share of the life insurance proceeds, thinking that the proceeds will pass equally to the other named beneficiaries (B & C).
However, under the terms of the insurance policy, if a named beneficiary is unable to take his or her share of the proceeds, then that share passes by default to the insured’s estate.
As already noted, D’s Will gives his entire estate to his second wife, W.
Thus, A’s disclaimed share of the insurance proceeds passes to his stepmother rather than to his siblings.

Conclusion

If used effectively and under the proper circumstances, disclaimers can be a very useful tool in planning and/or administering a decedent’s estate. They can be used to add flexibility to an estate plan or to fix a problem or otherwise obtain a better result in an estate administration. In short, they can get clients or advisors “out of a jam” when they are properly and timely employed.

However, if they are employed without a clear understanding of the relevant requirements and/or their operative effects, disclaimers can not only fail to solve a problem. They can in certain circumstances make matters worse. It therefore behooves practitioners to give careful and considered thought to their usage.

Author: Jeffery D. Scibetta

Originally published in October 2020