Understanding Disclaimers: What they are, what they mean, what to be aware of

Inheritance TaxWhen a person declines to receive inherited property they are said to have disclaimed it. Disclaiming an inheritance may seem like a strange thing to do, but it can actually be the best course of action for beneficiaries in some situations. A beneficiary may disclaim an inheritance, thus passing the inherited property to the next generation and obtaining the best possible tax advantages.

For example, should a parent leave money to affluent adult children, those children could disclaim the inheritance in order for the grandchildren to receive it instead. The money would then be taxed at the grandchildren’s tax rate rather than the adult’s rate. This could save a large portion of the inheritance from being taxed, as the disclaimed assets would not be included in the estate of the parent and subject to the estate taxes of the parent.

Disclaimers come in two varieties: qualified and nonqualified. Qualified disclaimers are generally the preferred method, as they can avoid potential additional taxation.

In an estate situation, a qualified disclaimer must be made less than nine months following the date of death of the deceased owner. The disclaimer needs to be in writing and signed by the disclaiming party. It must also correctly identify the property or interest being disclaimed. It must be irrevocable and done without conditions.

The person executing a qualified disclaimer is treated as if they predeceased the decedent for both inheritance and tax purposes. The disclaimed property then transfers according to the estate plan or the state intestate code to persons claiming through or under him or her.

A non-qualified disclaimer is one made more than nine months after death. A person making a non-qualified disclaimer is still treated as if they predeceased the decedent for inheritance purposes, but not for tax purposes. A non-qualified disclaimer can be taxed like a gift.

If, for example, a parent left money to their adult child, and that child executed a non-qualified disclaimer, the money would then go directly to the grandchildren. But for tax purposes, the child would be treated as if they received the property and then gifted it to their children. The non-qualified disclaimer exposes the adult child to a potential gift tax obligation that wouldn’t exist if they had executed a qualified disclaimer.

This is why qualified disclaimers are usually better than non-qualified disclaimers. A non-qualified disclaimer doesn’t guarantee an additional tax burden, but it makes it more likely.

Another form of disclaimer is the Disclaimer Trust. This is a trust that has embedded provisions, typically contained in a will, or a trust, that allow a surviving spouse to put specific assets within a designated part of the trust called a disclaimer trust, by disclaiming ownership of a portion of the estate. Disclaimed property interests are then transferred to the trust without being taxed. They are managed from other trust assets and can be distributed at the death of the surviving spouse in accordance with the terms of the disclaimer trust which is not included in the estate of the surviving spouse at his or her death.

Provisions can be written into the trust that administer regular payouts from it to support surviving family members. Surviving minor children can also be provided for, as long as the surviving spouse elects to disclaim inherited assets, passing them to the disclaimer trust.

For example, if you passed away and left your spouse an estate, they could disclaim some interests in it that could pass directly to the disclaimer trust as though it were the original beneficiary. Minor children could then benefit from regular payouts from the trust.

There are two major risks in using disclaimers. First, there is the risk that the person to whom the asset is given will not complete all of the necessary steps before the nine month deadline from date of the decedent’s death. If it is made upon someone’s death, a grieving person might simply forget to take the necessary action within nine months.

The second significant risk is that the beneficiary will receive the inheritance before executing the disclaimer. If a person cashes a check for life insurance, or even simply sends the insurance company a form claiming the money for themselves, they cannot later disclaim the insurance proceeds. Or, if a person receives income, such as interest, dividends, or rent earned on the gift, they cannot later disclaim the underlying asset. A person who disclaims property cannot have accepted the benefits of the property.

Disclaimers are useful estate planning tools, but it is essential to understand how they operate, the timing requirements, and the risks involved in using them in order to use them effectively.

To learn more about whether you qualify for a Social Security program or to begin your estate planning process, please contact us at Aaron J. Goldberg, PLC.

 

 

“Used with permission 2016”

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Attorneys with Aaron J. Goldberg, PLC are members of the Vermont Bar Association and the National Academy of Elder Law Attorneys.