A. Stephen McDaniel is the senior attorney with Williams, McDaniel, Wolfe & Womack, P.C., and the managing attorney for the firm's estate planning/probate section.  Steve's practice is limited to estate, charitable and business continuation planning, and probate and trust administration.  

Steve is a Fellow in the American College of Trust and Estate Council, a Certified Estate Planning Specialist by the Tennessee Commission on Continuing Legal Education and Specialization, an Accredited Estate Planner (AEP), and holds an Estate Planning Law Specialist (EPLS) designation awarded by the Estate Law Specialist Board, the only approved American Bar Association program which certifies specialists in the field of estate planning.

Steve is also Past President of the National Association of Estate Planners and Councils.

But perhaps most important to all of us who are grandfathers, Steve is a co-author of
A Grandparent's Guide to Gifted Children which covers the unique roles of grandparents, building a bond with a grandchild, and maximizing grandparenting.  

Steve uses PLR 200649023 as another good example of thinking outside of the box and finding a way to make a disclaimer work -  when the rules might suggest that it will not.   

You'll also find Steve's commentary gives LISI members a reason to take another look at disclaimers, one of our more powerful lifetime and post mortem planning tools. 

Executive Summary

The IRS approved a disclaimer of a limited power of appointment over a portion of trust property resulting in the property passing into a foundation controlled by the disclaiming party as Trustee. 

Facts

At death, Parent was survived by Spouse, Son and Daughter. 

Parent's Revocable Living Trust established a trust and granted Daughter a limited power of appointment over a portion of a trust in favor of multiple potential beneficiaries other than herself, her creditors, her estate or the creditors of her estate. 

To the extent that Daughter failed to exercise the limited power of appointment within one year of death of Parents, the assets passed to a foundation established by parent and managed by Daughter as Trustee.  The foundation qualified as exempt under § 501(c)(3).

Daughter did not exercise her power of appointment but, rather, proposed to disclaim her power of appointment over a portion of the trust. (The IRS does not tell us why Daughter wished to disclaim, just that she did.)

Prior to the disclaimer, Daughter proposed to amend the foundation documents (as allowed by the instrument) so that Daughter, as Trustee of the foundation, would have "no rights or powers with respect to the disposition of the property passing from the trust into the foundation as the result of the proposed disclaimer."

The amended foundation documents provided that the Trustee, other than Daughter, is directed to appoint a Special Trustee other than Daughter, the issue of the decedent, the Spouse of the decedent or any entity in which Daughter has an interest or serves as an officer, director or employee. 

The disclaimed assets will be held in a special segregated account by the foundation, separate and apart from other property of the foundation. 

The right to distribute income and/or principal of the special segregated account and to selected charitable recipients of such distributions will be held exclusively by the Special Trustee.  At Daughter's death, the special segregated account will be merged with the other foundation property and the rights of the Special Trustee will terminate.

The taxpayer requested a ruling that the disclaimer by Daughter will constitute a qualified disclaimer if the proposed changes to the foundation's governing instrument are made before Daughter executes the disclaimer.

Comments

8 REQUIREMENTS FOR VALID DISCLAIMER:

Before looking at the Ruling from the IRS, let's look again in more detail at the requirements for a qualified disclaimer. 

A disclaimer is "qualified" and will not be treated as a taxable gift by the disclaiming party if it is:

1.     Irrevocable.  The first requirement for a disclaimer to be "qualified" is that it be irrevocable. No definition of "irrevocable" is given by the IRS.  One could logically assume that the guidelines and rules associated with revocable transfers under Code Section 2038 apply.  Thus, where the disclaimer is subject to any exercise of a power to alter, amend, revoke or terminate the disclaimer, it would not be irrevocable.

2.     Unqualified Refusal to Accept the Disclaimed Property.  Again, the IRS gives no definition of the term "unqualified."  It is logical to assume that any disclaimer that is contingent upon another event, such as a disclaimer by yet another party, would not be an "unqualified" disclaimer.

3.     Identifies the Property to be Disclaimed.  Property to be disclaimed comes in many forms.  This PLR is a classic example of a disclaimer of what many might fail to recognize as "property," that is, a power of appointment.  The holder of a power may disclaim the power just as the beneficiary of the power may disclaim the right to inherit, even a contingent right.  Any interest in assets or a trust, including contingent remainder interests, may be disclaimed.  Life insurance, retirement plan benefits, and powers as a Trustee may be disclaimed.

4.     In a Writing Signed by the Disclaiming Party.  The Code provides no specific rules regarding the form of the writing.  However, state law may require that the disclaimer be filed in the Court having jurisdiction over the probate of an estate.  In these cases, the form and format is often established by state law.

5.     Received by the Transferor or his Legal Representative.  Note the word "or."  The transferor, that is, the party who makes the gift in the case of a gift is easy to identify and give notice to.  In the case of an estate, the transferor is deceased.  Thus, the disclaimer must be delivered to the legal representative of the estate.  One can assume that the "legal representative" is an Executor, Personal Representative, or any court appointed fiduciary, including a conservator or guardian.  An attorney in fact under a Power of Attorney may be a legal representative as is the Trustee under any trust which has or may have a relationship with the disclaimed interest or property.

6.     Timely Made.  This is perhaps the second most difficult requirement to meet.  The disclaimer must be made (except in the case where the disclaiming party is under age 21 or is otherwise disabled) within nine months of the date on which the transfer creating the interest is complete. 

·        In the case of a gift, this would be on the date that the gift is complete. 

·        In the case of an inheritance, the date can be more difficult.  For instance, in the case of a remainder interest, even a contingent remainder interest, the disclaimer must generally be filed within nine months of death even though the remainder interest will not vest for many years. 

·        In the case of a QTIP Trust established by husband for wife for life and then to the children, the children must disclaim within nine months of the date of the father's death.  This is true even though the assets are included in the wife's estate for estate tax purposes at her later death.  This should be contrasted with a general power of appointment trust for the spouse.  In that case, the children have the right to disclaim first at the father's death and then the right to disclaim again at the mother's death.  Seems strange!  You must know the rules to stay out of trouble.

7.     Made Prior to the Disclaimant's Acceptance of Disclaimed Property.  This is perhaps the most difficult of all requirements to satisfy.  The reason is at death if the disclaiming party accepts the bequest or exercises any dominion or control over the bequest, the general rule is that a qualified disclaimer cannot thereafter be accomplished.  NOTE:  That rule is subject to many exceptions created by counsel who took the time to think outside of the box.

8.     Passes without any Direction on the Part of the Disclaiming Party.  This is the rule that afforded the taxpayer in this PLR the most difficulty.  Where one seeks to disclaim property, but then retains some power to control the disposition of the property, or where the disclaimed property is held for the use and benefit of the disclaiming party, the qualified disclaimer is generally not possible. 

EXCEPTION WHERE DISCLAIMING PARTY IS DECEDENT'S SPOUSE:

Exceptions exist where the disclaiming party is the spouse.  In the case of a surviving spouse, the disclaimed assets may be held for the benefit of the spouse.  Thus, a spouse who receives an outright bequest can disclaim assets into a credit shelter type trust, removing the assets from the estate of the surviving spouse and, at the same time, allowing the surviving spouse to have the use and utilization of the disclaimed property for life.

DISCLAIMING LPOA - THINKING OUTSIDE THE BOX AND USING SPECIAL TRUSTEE:

In this PLR the taxpayer desired to disclaim not "property" or an inheritance but, rather, a limited power of appointment giving the taxpayer the right to direct assets to certain potential beneficiaries.  By disclaiming the power under the terms of the trust instrument, the assets passed immediately to the charitable foundation, controlled by the Daughters. 

On the surface, such an action leaves little concern.  However, because Daughter, as the disclaiming party, retained the right as Trustee of the charitable foundation to direct the disclaimed assets to charities of her selection, a qualified disclaimer could not ordinarily be accomplished.  She retained the authority as Trustee to direct the disclaimed assets to the charitable beneficiaries.  That would have been a fatal flaw.

But the advisors for Daughter did not give up.  In looking at the foundation more carefully, they suggested that if the disclaimed property was completely segregated and placed under the management of a Special Trustee appointed by the Trustee other than Daughter and outside of the control of Daughter, then she would have no ability to control the later disposition of the disclaimed assets, thus meeting the requirements of the last test and allowing the disclaimer to work. 

What We Learn from this Ruling

This Ruling is a classic case of counsel refusing to admit that a disclaimer was not possible even though Daughter, as the disclaiming party, would have normally retained control over the disclaimed assets passing into the charitable foundation which would typically prohibit the disclaimer. 

By amending the foundation documents and creating the Special Trustee and segregating the disclaimed assets away from the control of Daughter, a qualified disclaimer was possible and the client's goals were met.

7 ways to use Disclaimers Creatively:

Disclaimers are excellent estate planning tools.  They can be used in many ways including:

1.     Correcting Errors in Existing Estate Plans.  For instance, disclaiming a limited inter vivos power of appointment in a defective QTIP Trust saves the marital deduction.

2.     Post-mortem Planning where Lifetime Planning was either too Little or too Late.  Consider a Will that leaves $150,000 to Child A and the balance of the estate to Child B.  When written, the estate was $500,000.  The parent intended to favor Child B but at death, the estate was only $100,000 due to nursing home costs.  A disclaimer by A might save the relationship with his siblings!

3.     Transferring Substantial Assets to the Next Generation without Gift or GST Tax Consequences.  For instance, having the wealthy child disclaim the inheritance from the parents may allow the assets to pass to the grandchildren without further tax.

4.     Increasing the Marital Deduction to Reduce First Death Taxes. Creative disclaiming by the children may result in the assets going to the spouse by intestacy.

5.     Decreasing the Marital Deduction to Decrease Second Death Taxes.  An over funded marital share can be diverted to the children by the surviving spouse who disclaims.

6.     Terminating a Trust.  Where the holder of the life income interest disclaims, the trust will often terminate and immediately pass to the remainder beneficiaries.

7.     Protecting Assets from Creditors.  Why accept the inheritance if it will go to your creditors?  Check state law!

The Bottom Line

Effective representation of clients is best achieved by considering at the time of death whether a disclaimer offers an opportunity to produce benefits not contemplated when the estate planning documents which result in the transfer were originally drafted.  Thinking outside of the box and asking "what if" can benefit your clients in many ways.

Hope this helps you help others make a positive difference.

Steve McDaniel

Edited by Steve Leimberg

CITE AS:

 Steve Leimberg's Estate Planning Newsletter # 1081 (January 31, 2007) at http://www.leimbergservices.com    

Copyright 2006 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited - Except With Specific Permission.

CITES:

PLR 200649023; IRC § 2518, § 2038, PLRs 8603030, 8337069, 8908022, 8702024, 8409089, 8514095, 9301005, 8402121, TAMs 8701001, 8926001, 8546007, 9003007, 9247002.  TOOLS AND TECHNIQUES OF ESTATE PLANNING (800 543 0874).