Estate planning is almost never a lost cause. Even when it appears to be too late, there are estate planning steps that can improve existing plans. In fact, heirs and beneficiaries can make some smart estate planning moves to reduce taxes even after the loved one has passed away. Whenever you are dealing with someone else’s estate, you should be aware that any existing estete planning mistakes and oversights can be corrected or minimized. And a good estate plan that was hit by changed circumstances can be improved.
There are many postmortem estate planning strategies. But two strategies are the most common and effective.
One strategy, discussed in last month’s visit, is the alternate valuation date. An estate can be valued for tax purposes either on the date the testator died or six months later. When a market decline occurred in the months after the death, money might be saved by choosing the alternate valuation date.
The other strategy is known as the qualified disclaimer. It can be an extremely valuable tool.
In the qualified disclaimer, a person who is supposed to inherit property gives up the inheritance, or disclaims it. Then the property goes back into the estate and is inherited by someone else. The new heir is determined by the will or by state law.
Why would someone disclaim an inheritance? Let’s look at some specific examples.
You know that each spouse is entitled to give away up to $650,000 of property free of estate and gift taxes. (This will rise to $1,000,000 over the years.) But many people don’t include provisions in the estate planning to take advantage of that exemption. One spouse might not own $650,000 of property. Or the will might leave everything to the other spouse, which means the exemption of the first spouse to die is lost.
It could be wise for the surviving spouse to disclaim part of that inheritance after checking where it might go.
Under most wills it will go to the children or to a credit shelter trust that makes payments to the surviving spouse during his or her life, then to the children. If the surviving spouse already has enough assets to maintain his or her standard of living, why not disclaim the inheritance if it will go to the children? If the property would go to a credit shelter trust, it makes sense for the spouse to disclaim part of the inheritance even when he or she needs the money. It will go into the trust, be used to support the spouse, and will avoid estate taxes. The only thing that is lost is a big tax bill.
? Sometimes a non-spouse is left too much money in a will and the surviving spouse is left too little. This might happen when specific assets are left to individuals, and the values of the properties on the date of death are not what was anticipated. Or perhaps the total estate was smaller than expected, so the surviving spouse really needs all the assets. Whatever the reason, the spouse is left with less money than was intended or is needed.
Then, the non-spouse beneficiary can disclaim all or part of the inheritance. It likely will be transferred to the surviving spouse. Then the spouse can use the property for support and eventually leave what is left to the original beneficiary.
A disclaimer also can be used to save future income taxes. Suppose an adult in a high tax bracket inherits income-producing property. He doesn’t need the income and would eventually leave the income or property to his child anyway. The adult can disclaim the inheritance. Then the inheritance might shift to his child or children. This effectively allows the parent to make a gift to the children without paying any estate or gift taxes. It also shifts income and capital gains to the children’s tax bracket. That’s a double tax savings.
A disclaimer of this sort could result in a generation skipping tax on the estate. This tax is imposed when a grandparent tries to avoid a layer of estate taxes by leaving property directly to a grandchild. But each individual has a $1 million generation skipping tax exemption. So, many estates will be able to use this strategy without triggering extra taxes.
A disclaimer also might be used to save an IRA from extra taxes. You know from past issues that in many cases 60% of an IRA goes to the IRS, but that this can be avoided by careful selection of the beneficiary. An IRA beneficiary can disclaim the inheritance. Then the alternates named on the beneficiary form or state law will determine who inherits the IRA. Careful research of the tax consequences of an IRA inheritance and of alternate beneficiaries can allow a family to preserve the maximum amount of the IRA.
Disclaimers also can be used in special circumstances, such as ensuring that a family business can use the special qualified family-owned business deduction or even to increase the charitable contribution deductions of the estate.
There can be non-tax reasons for disclaiming an inheritance. If someone else in the family really wants specific property, the person named to inherit might disclaim it to preserve family harmony. Disclaimers also can be used to settle disputes that might otherwise result in litigation or to correct obvious errors in the will. A beneficiary with creditor problems might disclaim to ensure that his or her creditors do not end up with family assets.
More than one person can disclaim an inheritance of the same item. That’s where careful research can be helpful. When one person disclaims, the will or state law decides who is next to receive it. If that beneficiary also disclaims, the will or state law are consulted again. Sometimes multiple disclaimers are necessary for property to get into the right hands.
To work for tax purposes, a disclaimer must meet specific requirements. The disclaimer must be written and unconditional, and it must be made within nine months of the transfer. The person can disclaim after initially accepting the inheritance, but the person cannot have accepted any benefit from the property. For example, you cannot inherit bonds, collect interest on them for a few months, then disclaim them. And the person disclaiming cannot direct who gets the property.
Disclaimers are remarkably simple yet effective. They are a great way to handle unexpected changes or oversights in estate planning. In fact, some estate plans actually plan for disclaimers by setting up disclaimer trusts in the will. For example, if a couple’s assets are not yet above the tax-exempt amount but are likely to get there soon, a credit shelter trust can be set up to receive any property that is disclaimed. The trust will provide that the surviving spouse gets the benefit of the property for life, then the rest is inherited by the children.
When estate taxes are too high or the distribution of an estate doesn’t seem right, it is time to do some research. You might find that a few simple disclaimers can greatly improve the results.