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Estate Planning

How a Disclaimer Trust Works and Why Use One

1.  To “disclaim” means a person chooses not to accept an inheritance (such as when the survivor is listed as a beneficiary in a will, as a beneficiary in a trust, or as a beneficiary of a life insurance policy, annuity, 401k plan, or IRA).  If a person validly and timely “disclaims” an asset, then the IRS views it as though the person disclaiming never “owned” the asset (and the asset thus passes from the deceased person directly to the next person/charity/trust listed as the successor beneficiary.)

2.  A person “disclaims” by signing a special document (a disclaimer) where you irrevocably state that you choose not to accept the assets specifically listed in the disclaimer document. You can partially disclaim or you can fully disclaim. 

Example 1:  Wife Pam’s will states that all of her shares of Pepsi stock go to her husband Tom.  Pam dies owning 3,000 shares of Pepsi stock.  Tom can disclaim 22 shares, 100 shares, 1,542 shares, all 3,000 shares, or any other number of the shares.  

Example 2:  Husband Hal’s trust states that all trust assets go to his wife Jan (but if she disclaims any assets, then those disclaimed assets shall remain in a disclaimer trust for Jan’s lifetime).  When Hal dies, his trust owns a rental home (Blackacre) and a commercial building (Whiteacre).  Jan can accept ownership of both Blackacre and Whiteacre.  Jan can accept ownership of Blackacre, and she can disclaim Whiteacre (allowing Whiteacre to remain in the disclaimer trust).  Jan can accept ownership of Whiteacre and she can disclaim Blackacre.  Jan could disclaim both Blackacre and Whiteacre. Jan could accept partial ownership of Blackacre (such as one-third or one-half) and/or Whiteacre (such as one-quarter or three-quarters). 

Example 3:  Joe dies and his trust states that all of his Fanta stock goes to son Mike per stirpes.  If Mike disclaims any of the Fanta stock, then it will go to Mike’s children.  If Mike is well off financially, then Mike might choose to disclaims some or all of the stock so that his children will become stock owners.  (This is an example of a disclaimer in a non-spouse situation.)

3.  A disclaimer trust is established where Husband dies leaving assets to his surviving Wife.  Wife chooses not to accept all of Husband’s assets.  Wife signs a disclaimer document stating which assets she won’t accept.  Husband’s will or trust states that if Wife disclaims any assets, then those disclaimed assets shall remain in a disclaimer trust to provide specific benefits to the Wife during her lifetime (see # 6 below). 

4.  Disclaimer trust language can be put into a will or a revocable trust, stating that if the surviving spouse disclaims, the disclaimed assets can remain in a “disclaimer trust” to benefit the surviving spouse.  The purpose of setting up the “disclaimer trust” is because the assets of the disclaimer trust aren’t counted as belonging to the surviving spouse when he or she dies (and thus the disclaimer trust assets aren’t subject to inheritance tax when the surviving spouse dies). 

5.  The surviving spouse can be the sole trustee of the disclaimer trust or a co-trustee of the disclaimer trust (or another person could be the sole trustee).

6.  The disclaimer trust can provide the following benefits to the surviving spouse:

          (a)  all income can be given to the surviving spouse

          (b)  the trust principal can be available for the surviving spouse’s educational expenses, health expenses, and support & maintenance (meaning normal living expenses: food, clothes, housing costs, utility bills, etc.) or in ways to benefit the surviving children

7.  The surviving spouse should not be given a “limited power of appointment” to have authority to change the ultimate beneficiaries (the persons or charities who receive the disclaimer trust assets when the surviving spouse dies).  

8.  The surviving spouse has nine (9) months under federal law to decide whether to accept the assets left to him/her or to disclaim.  The nine months begins when the person owning the asset dies.

Example 1:  Joe owns a home and dies on January 15th this year.  The nine months begins on the day that Joe dies.

Example 2:  Sam and his wife Brenda own a vacant lot as joint tenants with right of survivorship.  Sam dies on July 5th this year.  Brenda has 9 months from July 5th to disclaim the one-half interest in the real estate that Sam owned.

Example 3:  Linda dies on August 7th this year.  Linda’s trust owns 1,200 shares of Microsoft stock.  The trust states that those stock shall be distributed to her son James per stirpes.  James has 9 months from Linda’s date of death to decide whether to accept ownership of all of the stocks, accept ownership of part of the stocks (and disclaim part), or disclaim all of the stocks.

9.  Once a person accepts ownership of an asset, then the person can’t disclaim that asset. 

Example 1:  Wife Nan dies and her trust states that all of the trust assets pass to her husband Jim.  Nan’s trust owns 500 shares of ABC stock.  Nan’s trust also owns 99 shares of XYZ stock.  Four weeks after Nan’s death, Jim transfers all of the ABC stock into Jim’s revocable trust.  Jim didn’t consult with a lawyer to discuss whether Jim should disclaim any of Nan’s assets.  Seven weeks after Nan dies, Jim decides to see an attorney.  Jim is wondering whether he can disclaim the ABC stock.  No, it is too late because Jim already transferred the stocks into Jim’s trust.  (Jim may disclaim any of the XYZ shares because those haven’t been transferred out of Nan’s trust yet.  Jim hasn’t made the XYZ stocks his yet.)  

Example 2:  Father Sam dies and his will states that his vehicle goes to his daughter Lois.  Lois has the vehicle transferred into her name. 

10.  By using the disclaimer trust method (rather than automatically requiring that some of the deceased spouse’s assets be held in a trust for the surviving spouse), the surviving spouse can choose (a) which assets he or she accepts as his/her own, and (b) which assets he or she desires be in the disclaimer trust. 

11.  The surviving spouse should consult with a lawyer within a few weeks of the death of the first spouse to die.  The pros and cons of creating a disclaimer trust should be discussed so that the surviving spouse can make an educated decision. 


 

Questions About Disclaimer Trusts

1.  Why set up a disclaimer trust?

          The purpose is so that the assets in the disclaimer trust aren’t counted as part of the surviving spouse’s estate (and thus aren’t subject to inheritance tax).

2.  How long does the surviving spouse have to decide whether to establish a disclaimer trust? 

          Under federal law, the surviving spouse has nine (9) months after his/her spouse dies to make a valid disclaimer. 

3.  What benefits can the disclaimer trust provide to the surviving spouse?

The disclaimer trust can provide the following benefits to the surviving spouse:

          (a)  all income can be given to the surviving spouse

          (b)  the trust principal can be available for the surviving spouse’s educational expenses, health expenses, and support & maintenance (meaning normal living expenses: food, clothes, housing costs, utility bills, etc.) or in ways to benefit the surviving children

4.  Can the surviving spouse determine who will inherit the assets when the surviving spouse dies? 

          No, if the husband dies first, his will/trust will state who receives the assets remaining in the disclaimer trust at the time of his wife’s death. 

5.  What if the surviving spouse becomes the owner of an asset and later wants to disclaim that asset?

          Once a survivor has become the owner of an asset (such as receiving a check for life insurance proceeds, changing a bank account into his/her name, having a deed recorded regarding real estate), then that person may not disclaim. 

6.  What if the first spouse’s will or trust doesn’t contain language to allow a disclaimer trust?

          Husband dies and he has a will (but not trust).  His will doesn’t contain any disclaimer trust language.  The surviving wife will have two choices: (a) accept the assets passing through the will to her, or (b) disclaim any or all of those assets, and then the disclaimed assets pass to the beneficiaries listed after her in the husband’s will.

7.  Are there any disadvantages in using a disclaimer trust?

          Because the assets in the disclaimer trust aren’t owned by the surviving spouse when he or she dies (and thus those assets aren’t part of the surviving spouse’s estate), there is no stepped up basis.  (The basis is the fair market value when the first spouse dies.  That basis doesn’t get stepped up again at the death of the surviving spouse.)  If the surviving spouse chooses not to disclaim assets into a disclaimer trust, in some families there is risk that when the surviving spouse dies there will be inheritance taxes assessed that would not have been had the surviving spouse disclaimed sufficiently to fund the disclaimer trust (and thus not put the disclaimed assets into the surviving spouse’s estate).  Obviously, the surviving spouse should seek professional advice from an attorney (and an accountant) after the first spouse dies. 

          Example:  Husband Al dies on May 5, 2006.  Al’s trust owns 1,000 shares of SuperSoda stock.  The shares are worth $25 each when Al dies.  Al’s trust states that all assets pass to his wife Joy (but any assets she disclaims will remain in a disclaimer trust for her lifetime).  Joy disclaims all 1,000 shares of the SuperSoda stock.  The SuperSoda stock is never sold when Joy is alive.  When Joy dies on June 1, 2009, a share of SuperSoda is worth $40.  Thus the 1,000 shares are worth $40,000.  The basis of the stocks (in determining capital gains taxes) is $25 per share (the value when Al died).  If Joy had owned the stocks when she died, then the basis of the stocks would be $40 per share (the value when Joy died). 

8.  What factors and issues would a surviving spouse probably want to consider in deciding whether to disclaim assets and thus create a disclaimer trust?

          The surviving spouse should think about the following items and issues:

          (a)  his/her age

          (b)  his/her health

          (c)  his/her standard of living

          (d)  the amount of his/her income

          (e)  what the tax laws are at that time

          (f)  what the tax laws will be (if there are changes scheduled to occur within the coming years)

          (g)  who the ultimate beneficiaries are

          (h)  which assets could be disclaimed that would not cause any capital gains taxes later to the ultimate beneficiaries: savings accounts, certificates of deposit

          (i)  which assets might be disclaimed that could cause capital gains taxes later to the ultimate beneficiaries: real estate, stocks, mutual funds

          (j)  is the surviving spouse expecting an inheritance from another source (such as his/her parents)

 

Copyright 2008 Ronald Runkle

Law Office of Ronald Runkle & Associates, P.C.
236 Center Street - Grayslake, IL 60030
Tel: (847) 548-5950 Fax: (847) 548-6085
email:ron@ronrunkle.com