The end of the estate tax during 2010 might only be a temporary reprieve. As the law now stands, beginning in 2011 estates valued above $1,000,000 will be subject to estate tax at very hefty rates rising as high as 55%. This circumstance suddenly creates the real possibility that the estates of surviving spouses who inherit more than $1,000,000 will ultimately incur a significant estate tax when they later die and before their estate moves on down to the couple's children. That's the bad news. But, the good news is that there may be an estate planning technique to minimize or avoid this result. It is called a "disclaimer."
A disclaimer is an irrevocable and unqualified refusal by a person to accept an interest in property. The disclaimer permits the intended recipient to reject all or a portion of a bequest, with the result that it then passes without estate or gift tax directly to the next person or persons named in the trust or will or, if none, then to the disclaimant's heirs at law. In many families, the next in line after the surviving spouse is usually the couple's children. With the threat of the return of the estate tax in 2011 for estates valued over $1,000,000, the surviving spouse of a person dying this year may now have good reason to consider a timely disclaimer. Doing so may eliminate tax as assets pass from the surviving spouse' estate on down to the couple's children. The use of disclaimers in this context is best explained by the following example:
John and Mary are a married couple and have a combined marital estate worth approximately $2,000,000. They have three loving children. If John dies in 2010, there would be no estate tax under current law. But if he leaves everything to Mary, her estate would then be worth $2,000,000. Absent a further change in the law, if Mary dies in 2011 or thereafter, the excess above $1,000,000 (i.e. $1,000,000) would then be subject to estate tax. Her estate would then owe hundreds of thousands of dollars to the IRS.
But there may be a way to pass the excess on to the children tax free: if within nine months of John's death she properly disclaims the excess above $1,000,000, the excess would then go directly to their three children, and the disclaimed portion would escape tax entirely on Mary's later demise because it would never have become a part of her estate. In addition, her retained $1,000,000 would also pass tax free, as it would be within her own exemption. The result: there would be no estate or gift tax, either at John's death or at Mary's later death, and the entire estate of $2 Million would then pass on down to their children tax free.
In order to make a valid disclaimer, there are some IRS rules that Mary must follow, including the following: (1) she cannot have used the disclaimed portion of the estate or received any benefit from it; (2) the disclaimed portion must pass without any direction by her (i.e., it must pass automatically to whomever is next in line -- presumably the children - and Mary cannot direct it elsewhere); (3) the disclaimer must be in writing; and (4) the disclaimer must be made within nine months of John's death. Under Internal Revenue Code § 2518, that portion of a bequest which is properly and timely disclaimed is considered as if it had never been transferred to Mary. Further, she will not even be deemed to have made a taxable gift to the children.
If Congress does not change the law this year, then for persons dying in 2010, the surviving spouse could disclaim any amount over the target $1,000,000, and the excess would go to the children free of estate tax. Alternatively, If Congress changes the law to limit the estate tax exemption to, say, $3.5 Million (i.e. the 2009 amount), then a surviving spouse could effectively disclaim any amount up to $3.5 Million and the disclaimed portion would then go to the children estate tax free.
Formerly, disclaimers were usually considered tools for decedents witih larger estates, as the exemptions through 2009 would easily protect up to $7,000,000 for married couples who had created an estate plan with tax shelter objectives. Now, however, persons with more modest estates should consider use of disclaimers. As of this writing, our recommendation to clients is as follows: (1) be sure that your estate plan includes disclaimer provisions in the trust or will; (2) watch developments in Congress closely over the course of the next several months of this year; and (3) wherever possible, delay closure of estates valued in excess of $1,000,000, so as to determine whether a disclaimer may be necessary in order to reduce or eliminate estate tax for downstream beneficiaries. In administering estates of persons dying this year, it might be advisable to take a "wait and see" approach to help decide whether a disclaimer might be necessary. Just be sure not to let the nine month time limit run on the right to disclaim.
Lastly, one cannot circumvent the limited estate tax exemption by opting to make large gifts during life. Except for annual exclusion gifts not exceeding $13,000/year/recipient, the $1,000,000 lifetime gift exemption is scheduled to remain in effect and will be charged against and thereby reduce the available estate tax exemption, so that one cannot "double up" and use both. Lifetime gifts in excess of this $1,000,000 will continue to be taxed at significant gift tax rates.
For further reading, see the author's article "Estate Tax Repeal Creates Dilemma: Some Spouses May Be Left Out In The Cold" - here.
About the Author
Gene L. Osofsky is an Elder Law attorney practicing in the San Francisco East Bay. You are invited to visit his website at http://www.LawyerForSeniors.com for more information, including a video on Long Term Care Estate Planning, a downloadable "Consumer's Guide to Medi-Cal Planning," and many articles on senior issues.