Some time ago my neighbor, a Wall Street lawyer, headed a citizens’ committee that succeeded in shutting down a brothel — the only one in our town since its founding in 1640. A few years later, the madam died and left her entire $2 million estate to my neighbor “in gratitude for the many enjoyable nights that we spent together.”
“This is terribly embarrassing; what should I do?”, my neighbor asked. I advised him to renounce — disclaim — the bequest. “But $2 million is a lot of money,” he said. When I reminded him that it would only be $1.6 million after taxes, he responded that $1.6 million was also a lot of money.
Nevertheless, he followed my advice. He disclaimed and we sued the madam’s estate for testamentary libel and the jury brought in a $2 million verdict — all tax-free.
Here’s how disclaimers can work in more common (and not cum grano salis) situations. Sometimes, objectives can be better achieved by disclaiming instead of accepting a bequest, because disclaimed assets can often be received in a more tax-advantageous way — for example, disclaiming a bequest can shift assets to children or others without gift tax liability. Disclaimers, as you shall soon see, can be used to make charitable gifts. And sometimes disclaimers can fix up estate plan muck-ups.
Flexibility. Disclaimers allow decisions to be made when the latest tax laws, the value of an estate’s assets and family circumstances are known — a second look, so to speak, at an estate plan.
How disclaimers work. As a disclaimant, you can’t designate the recipient of property bequeathed to you, but it can land where you want it to in a number of ways:
* The will or other instrument names an alternate beneficiary — for example, “If Daisy Buchanan disclaims my house in West Egg, it goes to Nick Carraway instead.”
* The disclaimed bequest goes to an alternate beneficiary under a will’s residuary clause.
* The disclaimed bequest passes under the applicable state’s intestacy laws.
Some details. To be effective, a written disclaimer must be received by the executor within nine months of the bequest. Furthermore, a disclaimant can’t accept any income or other benefits from the property. Be aware that both state and federal laws must be taken into account.
A disclaimer in favor of charity. Many generous individuals name charities in their wills. For those who aren’t ready to do that now, consider a back-up disclaimer gift. For example, Mark’s will gives his estate to his wife, Fulvia, his children and his grandchildren. He’d like to make a gift to his favorite charity, but only if the family is “comfortable with it” when he shuffles off this mortal coil. So, his will provides that all, or any part, of a bequest disclaimed by a family member shall go to the named charity or charities.
Another possibility — the contingent bequest. If my wife, Octavia, predeceases me, I give my residuary estate to Favorite Charity. That can also be provided in life insurance and pension plan designations.
Here’s a real-life case (discussed in Letter Ruling 199929027) where the charity was a private foundation. Because the charity was a private foundation (and not a public charity), the parties had to jump through some hoops. Elizabeth’s will gave her jewelry, automobiles, artworks and other tangible personal property to her husband. If he didn’t survive her, those items were to go to her surviving children. Any lapsed legacies were to go to Private Foundation. The husband didn’t survive her, so the tangible personal property was to go to her sons, Albert and Barton.
The sons told the IRS that they planned to disclaim 13 paintings that would thus go to Private Foundation. They represented to the IRS that the paintings had not been distributed by the estate and that they had not accepted the paintings or any benefit from them. At first, the paintings remained in Elizabeth’s apartment. Then, they were put in storage. At their mother’s death, the two sons and a daughter-in-law were members, directors and officers of Private Foundation.
The sons represented to the IRS that they took a number of steps to insure that neither of them, as members, directors or officers of Private Foundation, would have any power to dispose of the paintings (or the proceeds from any sale thereof) received by Private Foundation as a result of the disclaimers. The existing directors appointed four additional members. Albert and Barton had already irrevocably waived and renounced the right while Private Foundation holds the paintings to:
(1) participate in the election and/or removal of members and directors of Private Foundation;
(2) participate in the appointment of directors to any committee formed to administer and dispose of the paintings (or the proceeds from their sale); and
(3) participate in the exercise of any control, as a member, director or officer, in the administration or disposition of the paintings (or the proceeds from their sale).
The sons also represented to the IRS that the estate contained sufficient assets to fund any pre-residuary bequests, so that the disclaimed paintings would pass to Private Foundation.
The IRS ruled that if the disclaimers are received by the decedent’s legal representative (or the holder of legal title to the property) not later than nine months after Elizabeth’s death, then the disclaimers will be qualified under IRC Section 2518, and Elizabeth’s estate will be entitled to an estate tax charitable deduction for the disclaimed paintings received by Private Foundation.
To disclaim or not to disclaim? Before I went to law school, I would have had a three-word answer: “I don’t know.” But after practicing many years, I still have a three-word answer: “Well, it depends.”
© Conrad Teitell 2012. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.