Before advising a client to make a disclaimer, practitioners should carefully consider all of the potential ramifications.
Author: Jeffery D. Scibetta
Originally published in October 2020
Copyright © 2020 Knox McLaughlin Gornall & Sennett, P.C.
A disclaimer is an affirmative refusal to accept an interest in property that would otherwise be received, whether during lifetime (by way of gift) or at death (through an inheritance or bequest).
Elements of a Gift. To better understand the notion of a disclaimer, it may help to consider that the elements of a gift are (1) donative intent, (2) delivery of the gifted item, and (3) acceptance of that item. Although the requirements are ordinarily considered in the context of a lifetime gift, the same elements are arguably present in any gift, whether made during lifetime or at death. A disclaimer can therefore be thought of as an action on the part of the would-be recipient that negates the existence/occurrence of the third requirement listed above (acceptance), thereby nullifying the gift from a legal standpoint.
Effect of Disclaimer (Generally). If the disclaimer is effective, the disclaimed property is considered not to have ever been gifted to the donee, and therefore the property is treated as still belonging to the donor (if there are no alternate takers) or as passing directly from the donor to whomever was next-in-line to receive it (where there are alternate takers).
Disclaimer as a Legal Tool. Disclaimers can serve as a tool for estate planners in circumstances where a recipient of property prefers not to receive the property given to him.
Not a Panacea. Although disclaimers are tactically an important “arrow in the quiver” of estate planners, they are nevertheless, not an all-purpose solution to problems in estate planning. Before advising a client to make a disclaimer, practitioners should carefully consider all of the potential ramifications.
Pre-Death Disclaimer Planning. Disclaimers are often part of estate planning both before and after a decedent’s death. Pre-death disclaimer planning is typically intended to add flexibility to an individual’s estate plan to allow for unknown future circumstances. Pre-death planning typically involves drafting estate plan documents that allow for the exercise (use) of the disclaimers after the individual’s death.
Examples. Examples of “pre-death” disclaimer planning include:
Post-Death Disclaimer Planning (a/k/a “post-mortem” planning). Disclaimers are also frequently utilized in planning related to a decedent’s estate administration. This type of “after-death” planning (also referred to as “post-mortem” estate planning) is typically when the disclaimers are made. Disclaimers are often used in a post-mortem estate context in order to accomplish different goals, including:
In General. Disclaimer planning can be complex for various reasons, including the following:
Importance of Understanding the Ramifications of Disclaimers. It is critically important that practitioners and clients understand the issues and ramifications related to the use of disclaimers. Although disclaimers can be successfully used to minimize or even eliminate various problems related to an estate administration, that is certainly not always the case.
Furthermore, if a disclaimer is unsuccessfully attempted or is made inadvisably, it can have serious (and possibly unforeseen) consequences, and it can sometimes make a situation worse rather than better.
Applicable Laws. Disclaimer planning can potentially involve a number of different areas of state and federal law, including
What happens if the requirements for a disclaimer are not met?
Failure to Meet the State Property Law Requirements. – If the state property law requirements for an effective disclaimer are not met, then the disclaimer will, by definition, not be effective and the disclaimant will generally be treated as having received (and thus as now owning) the disclaimed asset.
Failure to Meet the Tax Law Requirements. – If the requirements for an effective disclaimer under federal or state tax law are not met, then a disclaimant will be treated for tax purposes as having received the disclaimed assets and then transferred the disclaimed asset to the eventual recipient. However, that does not necessarily mean that the disclaimant will be the legal owner of the assets that he unsuccessfully attempted to disclaim. If the property law requirements (but not the tax law requirements) for an effective disclaimer are met, then the disclaimant could be treated as having made a transfer of the asset for tax purposes, even though he in fact still owns it – an anomalous circumstance which many clients probably would not even understand let alone anticipate.
Importance of Disclaimer Requirements. So as a practical matter, if the use of a disclaimer is intended primarily to accomplish a tax objective (as is commonly though not always the case), then it will be necessary to meet the state substantive law requirements as well as any additional tax law requirements for making an effective disclaimer.
Critical Issues. Before making a disclaimer, an individual should always consider three very important issues:
“By whatever means.” The applicable statutory law in Pennsylvania states that a disclaimer can be made by “[a] person to whom an interest in property would have devolved by whatever means …” (
20 Pa.C.S. §6201) (Emphasis added.) Based on the quoted language (“by whatever means”), the intent on the part of the legislators appears to have been to make disclaimers broadly available to a wide array of potential recipients.
Examples of Disclaimants. The statute goes on to list, by way of example, the following persons as entitled to make a disclaimer:
Disclaimers by Fiduciaries on Behalf of Others. Disclaimers are typically made by the person(s) who would otherwise benefit from the interest being disclaimed, as noted above. However, disclaimers can also be made in certain circumstances on behalf of other persons, including:
Generally, a disclaimer made on behalf of another person (including those under the circumstances listed above) requires court approval in order to ensure that the disclaimer does not materially prejudice the rights of the persons on whose behalf the disclaimer is made or their creditors. However, an executor can make a disclaimer on behalf of an estate without court approval if the decedent’s Will expressly authorizes the executor to do so.
Transfers during Lifetime. As previously noted, many different types of interests in (or powers over) property may be disclaimed, including interests (or powers) conveyed during the donor’s lifetime and at death. Lifetime transfers would include those made outright and free of trust (such as a gift or money or property to a particular person) and those made in trust.
Transfers at Death. Disclaimable testamentary interests include:
“In Whole or in Part”. The Pennsylvania disclaimer statute specifically states that the party making a disclaimer can make that disclaimer “in whole or in part.” So, as in most states, Pennsylvania law allows for complete or partial disclaimers. Stated differently, a person can disclaim all interest or only part of their interest in the subject property (20 Pa.C.S. §6201).
Although the tax laws typically also allow for the making of a complete or partial disclaimer, they often set forth more detailed requirements that must be met in order for a partial disclaimer to be effective. That is particularly the case for federal estate and gift tax.
Full requirements for an effective disclaimer can be found in Pennsylvania Estate and Trust Law [20 Pa.C.S. §6201 et seq.]
Generally, the Pennsylvania Estate and Trust Law Requirements for a Disclaimer include the following:
The Problem: Mom really needs more than just one-half (1/2) of the estate to live on, and son recognizes that, and agrees that the decedent would have wanted everything to go to his/her surviving spouse if he had gone to the trouble of having a Will prepared.
Possible Solution: Son could disclaim all or a part of his inheritance from dad in order to provide for mom.
The Problem: Reasons why a Spouse might want less than all of the assets
Possible Solution: If the spouse files a disclaimer, then the disclaimed assets could pass under the terms of the Will to the decedent’s children.
Money Owed to IRS. If an individual makes a disclaimer for the purpose of avoiding an obligation to the federal government, he or she is unlikely to be successful. The issue has arisen in a number of instances where a taxpayer owed money to the Internal Revenue Service (“IRS”) and was encumbered by a federal tax lien. The taxpayer is the beneficiary of an estate but, in an effort to avoid paying the government, disclaims his inheritance. Although there have been some cases where courts have ruled to the contrary (See, e.g., Leggett Estate v. U.S. 97-2 USTC ¶60,286 (5th Cir. 1997); Mapes v. U.S. 15 F.3d 138 (9th Cir. 1994)), the clear issue appears to have been resolved in the government’s favor (Drye v. U.S. 120 S. Ct. 474 (1999); see also Tanari v. U.S. 78 AFTR 2d 96-2, ¶50,460 (E.D. PA. 1996)).
For planning purposes, employing a disclaimer to avoid paying a federal government obligation, such as a tax lien, is therefore a seemingly dubious proposition.
Disclaimer to Avoid Medicaid Obligations. Another strategy that is unlikely to prove successful is to disclaim assets in an attempt to become (or remain eligible for Medicaid). Prior to 1993, there was some question as to whether a disclaimer would be counted as a disqualifying transfer for Medicaid purposes. However, in 1993, Congress broadened the definition of a “transfer” for Medicaid to include disclaimers as a disqualifying transfer (42 U.S.C. §1396p(c)). According, if a Medicaid applicant disclaims assets within the pertinent five (5) year “look-back” period, the disclaimer will cause the applicant to be ineligible for Medicaid for a period of time.
Bankrupt/Insolvent Beneficiary. If the disclaimant’s obligation is not to the government but instead owed to private individuals, then the answer is less clear cut. The pertinent Pennsylvania statute states that “[n]othing in this section shall determine the effect of a disclaimer upon rights of creditors of the disclaimant.” (20 Pa.C.S.A. §6205(d)). However, in at least one Pennsylvania appellate court case, the court set aside a disclaimer for the benefit of creditors where the disclaimant was insolvent at the time of the decedent’s death (Gallagher v. Riddle, 850 A.2d 748 (Pa. Super 2004)). The issue would most likely be framed as whether the disclaimer should be viewed as a “transfer” for the purpose of the state fraudulent conveyance law. Although the issue has not been definitely resolved as of this writing, it would seem reasonable to argue that a disclaimer should be so construed, particularly if the disclaimant is insolvent at the time the disclaimer is made. Accordingly, from a planning standpoint, the safest course may be to avoid the use of a disclaimer in an insolvency or bankruptcy context.
Solvent Beneficiary. If the disclaimant is insolvent or bankrupt, the chance of success is presumably better, although the issue has not yet been directly addressed. The outcome might depend on the particular facts involved. For example, if the disclaimant was not already insolvent when the disclaimer was made, how solvent was he at that time? Did he ultimately become insolvent? If he ultimately became insolvent, how years or months was it after he made the disclaimer?
Failing to achieve a Federal Tax Requirements. As just noted, disclaimer may not be successful because it was made in a way that fails to meet all of the applicable requirements. That is particularly true when a disclaimer is filed with a specific tax-related objective in mind. Disclaimers are often strategically used in federal estate and gift tax planning to achieve a desired end. If the disclaimer fails to meet the requirements for a disclaimer under federal tax law, it more than likely will fail to meet the desired objective.
Disclaimer made to qualify for the Marital Deduction. As just noted, disclaimers are often utilized in a post-mortem context to meet various objectives. A commonly sought objective in federal estate tax planning is to qualify for (or increase) a marital deduction. One situation where the issue can arise is when a decedent bequeaths assets to a trust that is intended to benefit a surviving spouse (a “marital trust”) but which does not meet all of the requirements for the marital deduction. Under such circumstances, a disclaimer can sometimes be used to cure one or more of the trust’s defects and thereby qualify it for the marital deduction. However, that goal will typically not be met if the disclaimer does not itself meet all of the federal tax requirements for a Qualifying Disclaimer.
Example: Husband (“H”) dies in 2020. H’s Will bequeaths his entire estate to W as trustee of a testamentary trust intended to primarily benefit his wife (“W”) during her lifetime and to also qualify for the Marital Deduction for federal estate tax purposes. Under the terms of the trust (as set forth in H’s Will), all trust income is distributable each year to W as the surviving spouse throughout her lifetime, but the trustee is also authorized to distribute trust principal to W or to any of their children.
Because of the Trustee’s authority to distribute trust principal to persons other than W, the trust does not qualify as a “QTIP” trust (i.e., a trust eligible for the Marital Deduction).
W therefore disclaims her right as trustee to distribute principal to the children in the hope of qualifying the trust for the Marital Deduction. However, a successor trustee would still have that same power, and so the disclaimer does not effectively extinguish the power. Only a disclaimer by the children (as permissible beneficiaries of the fiduciary power) would qualify the trust for the Marital Deduction (See TAM 8729002).
Example: Husband (“H”) dies in 2020. H’s Will bequeaths his residuary estate to his wife (“W”). The Will further provides that any assets disclaimed by W pass into a testamentary trust that benefits W during her lifetime. Under the trust terms (as set forth in the Will), all trust income is required to be distributed each year to W and the trust principal may be distributed at the trustee’s discretion to W as needed for her health, education, maintenance or support. W is also given a testamentary power to appoint any remaining trust assets (at the time of her death) in favor of any of her children. Any un-appointed trust assets pass in equal shares to the children.
W disclaims the residue which then passes into the trust. W retains her power to appoint the trust assets at her death. Because W retains the power to appoint the trust assets, the disclaimed assets do not pass “without direction” by the disclaimant (i.e. W). The disclaimer is therefore not a Qualified Disclaimer. Because the disclaimer is not qualified, the disclaimed assets are not treated as passing directly from H into the trust that could qualify for the Marital Deduction.
Failing to Meet State Tax Requirements. Disclaimers are also commonly used to meet tax planning objectives at the state level as well. If a disclaimer fails to meet applicable state tax requirements, the disclaimer more than likely not meet the desired objective.
Example: H is survived by his wife, W and by 2 children, S and D. H dies without a Will and so his estate passes under the intestacy statute in roughly equal shares to W and to the children (with spouse getting one-half and the children getting the other half). (Assume for the purpose of this example that S and D do not have any children of their own.)
S and D do not need their inheritance, and would just as soon see their shares go to their mother. They also prefer not to have to pay PA inheritance tax. So S and D both disclaim their shares of H’s estate with the intent that those shares pass to W. (Assume that S and D both do not have any children of their own.)
However, S and D fail to make their disclaimers within nine (9) months of H’s death. Their disclaimers are therefore effective for PA property law purposes but not for PA Inheritance Tax purposes. Therefore, the disclaimed shares of the estate will be treated for PA tax purposes as passing first to S and D and then to W. Accordingly, S’s and D’s objective of avoiding PA Inheritance Tax is not met.
Another way that a disclaimer can “fail” is if the disclaimant fails to fully take into account all the relevant ramifications of making the disclaimant. If a disclaimer was not the correct “tool” to use in the first place, then the fact that all of the specific requirements may have been met will be “cold comfort” to the advisor who recommended that course of action.
Importance of Knowing Ultimate Recipient. One of the most important things to understand before making a disclaimer is where the disclaimed assets will ultimately pass. Put simply, if the disclaimant does not get the disclaimed assets, then who is next-in-line to receive them? If an individual makes a disclaimer without knowing the answer to that question, disastrous consequences can ensue.
Example: H dies intestate, and is survived by his wife, W, and his two children, S (his son) and D (his daughter). Assume that S and D each have two children of their own. The grandchildren are all minors.
Example: Decedent (“D”) bequeaths assets all of his assets to his (second) wife (“W”), who is not the mother of his three (3) children (A, B & C). In order to provide something for his children, D designated each of them (A, B & C) as equal beneficiaries of an insurance policy on his life.
If used effectively and under the proper circumstances, disclaimers can be a very useful tool in planning and/or administering a decedent’s estate. They can be used to add flexibility to an estate plan or to fix a problem or otherwise obtain a better result in an estate administration. In short, they can get clients or advisors “out of a jam” when they are properly and timely employed.
However, if they are employed without a clear understanding of the relevant requirements and/or their operative effects, disclaimers can not only fail to solve a problem. They can in certain circumstances make matters worse. It therefore behooves practitioners to give careful and considered thought to their usage.
Author: Jeffery D. Scibetta
Originally published in October 2020
Copyright © 2020 Knox McLaughlin Gornall & Sennett, P.C.