Disclaimer Planning During Uncertain Tax Times

The Economic Growth and Tax Relief Reconciliation Act of 2001 incrementally raised the federal estate tax applicable exclusion amount (“exclusion amount”) from $675,000 to $3,500,000 over a decade, ending with a full repeal in 2010. Now we have The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 setting the exclusion amount at $5,000,000 for 2011 and 2012 (adjusted for inflation in 2012), and allowing the surviving spouse to use the unused exclusion amount of his or her predeceased spouse who died in 2011 or 2012. What’s next depends on whether Congress enacts new estate tax legislation or allows the law to revert to a $1,000,000 “use it or lose it” exclusion amount in 2013.

The frequent changes to the exclusion amounts in recent years created much confusion for people with estate plans tied to the exclusion amount. Such exclusion amount increases could result in more property than intended passing to one set of beneficiaries and not enough passing to another. For example, if a decedent has a $5 million estate and the formula used in his estate planning documents prepared years ago provides for the exclusion amount to pass to his children, then his spouse may inadvertently be disinherited if he dies during 2011 or 2012.

With such uncertainty in the estate tax laws, many couples are utilizing “disclaimer trust” planning as a flexible tool which puts control of the estate plan in the hands of the surviving spouse. A disclaimer trust plan can be effectively implemented if a spouse owns sufficient assets to maximize use of his or her exclusion amount. If so, he or she then executes estate planning documents devising his or her assets outright to, or in a marital trust for, his or her spouse but provides that if his or her spouse disclaims any assets, such disclaimed assets pass to a separate estate tax exempt trust (“disclaimer trust”) for the benefit of his or her spouse (and other beneficiaries if desired). The surviving spouse can be the Trustee of the disclaimer trust provided his or her authority to make discretionary distributions is limited to distributions for a beneficiary’s health, maintenance, education or support. This type of estate plan is very flexible because it allows the surviving spouse to make decisions concerning the creation and funding of an irrevocable estate tax exempt trust with full information (such as information concerning the survivor’s assets, current tax laws, survivor’s needs, etc.).

There are, however, some drawbacks to this type of planning. Use of this estate plan requires complete trust in the surviving spouse since the surviving spouse cannot be required to make the disclaimer and could inherit the assets and then dispose of the assets in a different manner than initially agreed. In addition, state laws governing disclaimers may prohibit a disclaimer by a surviving spouse with financial or creditor problems. Another disadvantage to this type of estate plan is that a surviving spouse cannot have a power of appointment over the disclaimer trust which would allow, for example, the surviving spouse to appoint the trust at his or her death in a manner different from what the trust provides.

Executing estate planning documents is only part of disclaimer planning. Wills and trusts do not control the disposition of an asset held as tenants by the entireties, jointly with rights of survivorship, or those assets having a designated beneficiary such as a life insurance policy, IRA or other retirement plan. Florida law does, however, allow a surviving spouse to disclaim the survivorship interest in such assets and, with proper planning, an effective disclaimer of such interest can result in the disclaimed interest passing consistent with the estate plan. For example, a spouse may designate their spouse as primary beneficiary of his or her IRA and provide that if his spouse disclaims any part of the IRA, the disclaimed portion will fund the disclaimer trust. This requires that a proper beneficiary designation be made for the IRA.

Finally, a disclaimer will be valid for tax purposes only if it is properly executed within nine months from the death of a decedent (however, for decedent’s dying during 2010, a disclaimant has until September 19, 2011 to make a valid disclaimer), and prior to the disclaimant “accepting” the property. Acceptance is essentially exercising the rights of ownership. A spouse who is contemplating a disclaimer should not exercise any control over an asset (such as writing a check on a joint account if considering a disclaimer of the deceased spouse’s interest in the account, or claiming insurance or other assets passing by beneficiary designation).

Disclaimer trust planning is not for everyone, but for many it provides a flexible planning option during these uncertain tax times. If this type of planning is appropriate for you, you will want to be sure appropriate documents are executed, your assets are titled appropriately, your beneficiary designations consider possible disclaimers and the beneficiary takes no actions which would make a disclaimer ineffective for tax purposes.