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The Very Versatile Disclaimer: A Guide to Its Use in Charitable Planning

Planned Giving Today

Originally Published in Planned Giving Today.

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One of the most important tools in charitable planning is also among the least familiar to planned giving officers: the disclaimer. It is, in addition, one of the most versatile of all planning devices, and the depth of the potential for its use in the charitable arena, still largely unplumbed, is limited only by the creativity of the planned giving officer and the other members of the planning team.

The applications to which the disclaimer has already successfully been turned include:

  • The creation and fashioning of charitable deductions for tax-sensitive estates;
  • The acceleration of the charitable remainder interests in charitable remainder trusts; The preservation of the charitable deduction for nonqualifying split-interest trusts; and,
  • The resolution of estate litigation involving charitable interests.

Even the charity itself may find it expedient to disclaim interests to which it is entitled under a will or trust.

“No Thanks”

In essence, a disclaimer, or “renunciation” as it is sometimes called, is a formal way of saying “no thanks” to an offered gift or bequest, and letting the gift or bequest “fall” to the next taker in line. Consider the following example, taken from a recent private letter ruling issued by the Internal Revenue Service (the “Service”):

D’s will left her entire estate to her brother, B, provided that B survives D. If B failed to survive D, the will directed that D’s estate be sold at auction. A portion of the sale proceeds were to pass to named individuals, with the rest of the sale proceeds to pass to a qualified charity.

Within nine months from the date of D’s death, B filed a written irrevocable disclaimer with the executor of D’s estate and with the probate court. The terms of B’s disclaimer provided that B disclaimed all of his interest in D’s estate except for certain specified real and personal property and a specific amount of cash.

The effect of B’s disclaimer under applicable state law was that the disclaimed assets passed in part to the named individuals, with the rest passing to the charity. The estate qualified for the charitable estate tax deduction, as it would not have if B had not disclaimed. [See PLR 9616001 (December 13, 1995).]

Section 2518

For many years, the law of disclaimers was in considerable confusion. Wide variety existed from state to state, and the federal standard was not fully articulated until the adoption of Internal Revenue Code (“Code”) Section 2518, effective for disclaimers made after December 31, 1976. Spurred on by the adoption of the federal standard, most states enacted legislation revising the local disclaimer and renunciation laws to bring them into conformity.

In brief summary, Code Section 2518 provides that a disclaimer will be effective for federal gift and estate tax purposes if these requirements are met:

  1. The disclaimer is in writing;
  2. The disclaimer is received by the person making the gift or bequest, or his or her executor or other legal representative, or the holder of legal title to the property involved, within nine months from the later of—
    1. the date on which the gift or bequest is made, or
    2. the date on which the disclaimant (the person making the disclaimer) reaches age 21;
  3. The disclaimant has not accepted the gift or bequest or any of its “benefits” and
  4. As a result of the disclaimer, the property must pass without any direction by the disclaimant, and must pass either—
    1. to the spouse of the decedent, or
    2. to a person other than the disclaimant.

The key elements of this federal standard are:

  • The prohibition against the acceptance of any “benefits” in the disclaimed property by the disclaimant; and
  • The requirement that the disclaimed property “fall” to someone other than the disclaimant, without any “direction” on the disclaimant’s part. If in our opening example, B had already received the assets from D’s estate and had invested them in his stock portfolio, it would probably be “too late” for B to disclaim the assets, even if he disclaimed them within the nine-month period following D’s death. Similarly, if the will had given B the right to direct who should receive the disclaimed assets, the disclaimer would likely fail, a principle which can destroy an otherwise sound disclaimer plan in the charitable arena, as we shall see.

Disclaimable Asset

Exactly what sorts of assets and interests can be disclaimed is, in general, determined by the particular state laws involved. Certainly gifts and bequests can be disclaimed. Depending on state law, so may interests in trusts, interests in insurance policies, assets passing by beneficiary designation (including IRAs, CDs, and pension plan benefits), and perhaps various powers over assets. Because of the persistent wide variety among the laws of the different states on these issues, it is crucially important that state law be examined before the “charitable” disclaimer is made.

In addition (as usual), the Service has issued lengthy, complex regulations dealing with disclaimers, and these, too, must be carefully sifted and parsed prior to the “charitable” disclaimer. But the advantages of the “charitable” disclaimer are frequently well worth the effort.

Quick action by an alert planning team helped rescue an estate tax charitable deduction with the use of a disclaimer in PLR 8031018 (March 21, 1980), for example. The decedent’s revocable trust created a non-qualifying charitable remainder unitrust, of which the decedent’s wife was named as individual beneficiary. Following wife’s death, apparently shortly after the death of the decedent, her executor made a timely, qualified disclaimer of all of her interest in the charitable remainder unitrust.

Under Virginia law, as under the law of most states, it was legally “presumed” that wife had predeceased her husband, although he in fact died first. This legal fiction proves quite useful, and in the circumstances reviewed in the ruling, the Service concluded that wife’s interest in the flawed unitrust in fact never existed. The charity became entitled to the full interest in the flawed unitrust, retroactive to the husband’s death. The flawed unitrust was successfully bypassed, and the charitable estate tax deduction was saved.

An earlier article appearing in these pages summarized the critical role of a disclaimer in “accelerating” a charity’s remainder interest under a charitable remainder trust. See G. Treacy, “Accelerate Your Charity’s CRT Interest,” Planned Giving Today, April 1996.

Directing Assets

Occasionally, a will provides that, if a disclaimed interest passes to charity, the disclaimant, alone or in conjunction with others, will have the right to direct the disposition of the disclaimed assets, perhaps among a list of charities. What is the effect of this sort of provision, in light of the Code’s prohibition against the “direction” of the disclaimed assets by the disclaimant? This question has been the subject of a series of rulings, which set forth a reasonably clear road map for dealing with the concern.

For example, in PLR 9350033 (September 22, 1993), the decedent’s will provided that the “residue” of her estate would pass to her husband through certain trusts. The will further provided that, if husband were to disclaim the marital gift, the disclaimed portion would pass to one or more of three listed charities, in shares, to be selected by the trustees.

As the careful reader might have guessed, husband was one of the trustees, and also served as an officer and trustee of two of the candidate charities. He wanted to disclaim a portion of the marital trust, but to do so without further planning would trigger an inadvertent violation of the Code’s prohibition against “direction.” In order to avoid this unpleasant result, which would have sunk the estate tax charitable deduction, husband first resigned as trustee of the marital trust.

In addition, the internal regulations of the charities were amended to provide that the disclaimed funds would be administered in a new, separate fund, to be controlled by persons other than husband. Husband would take no part in any action relating to the separate fund. These changes effectively removed husband from any role of influence over the disclaimed funds received by the charities. Because husband was no longer in a position to “direct” what happened to the disclaimed funds, he could safely sign the disclaimer. The Service approved of these steps, and ruled that the disclaimed assets qualified for the estate tax charitable deduction.

Similar “anti-direction” measures were successfully employed in PLR 9319022 (February 9, 1993), and in PLR 9235022 (May 29, 1992). See also, PLR 8626046 (March 27, 1986). As these private letter rulings, and the others summarized here, can technically be relied upon only by the requesting taxpayer, the planning team embarking on similar paths are well advised to consider seeking their own ruling.

Reverse Disclaimers

May a charity itself disclaim an interest it receives under a will or trust? This sort of “reverse” charitable disclaimer may be appropriate if the charity would rather not accept, say, environmentally dubious realty, or if the charity seeks to avoid a will contest or other litigation in order to preserve good relationships (and good donor prospects). The Service has ruled that such a “reverse” charitable disclaimer is valid. In PLR 9222041 (February 28, 1992), the Service considered a will under which husband directed that the residue of his estate, including certain stock, was to pass to a marital trust for his widow. On her death, the marital trust was to terminate, and its assets were to be distributed to a charity. Widow decided to disclaim her interest in the stock as beneficiary of the marital trust, and the charity followed suit.

The charity commenced a court proceeding, and joined the state attorney general as a party, asking the judge to issue a ruling permitting the disclaimer of the stock. The judge so ruled, and the charity’s disclaimer permitted the stock to pass to the children under the state’s laws of intestate succession. The ruling is silent on the motives of the charity–perhaps it sought to avoid litigation or hurt feelings on the part of the disinherited children; or perhaps it deemed it the wiser course to seek an even greater gift from the children themselves in the future.

Whatever its reason, the charity was well advised to proceed through the courts as it did. Without the support of the judge’s order allowing the disclaimer to be made, the charity may well have faced the accusation that it was “wasting” valuable assets, and that its trustees would thereby be breaching their fiduciary duties. Other charities considering such a “reverse” disclaimer–including yours–should certainly consider taking similar precautions.

Faulty Disclaimers

Even outside the realm of “reverse” charitable disclaimers, the charity and the planning team should always carefully assess the circumstances and analyze the applicable law before a disclaimer of the sort considered here is put in place. Any number of potential obstacles, some of them quite subtle, can torpedo the effectiveness of the disclaimer plan. Perhaps the most important consideration is whether the will, trust, or state law will pass the disclaimed interest in the “right” direction. Will the disclaimed assets pass to the charity, or will they “fall” to the decedent’s heirs under the laws of intestacy? Ideally, the will or trust language clearly and expressly provides for the ultimate fate of the disclaimed assets. Be aware, however, that many wills and trusts, even those prepared by competent counsel, fail to do so. If the will or trust is silent, then state law controls the issue, and state law should consequently be scrutinized in advance.

Other factors that can ruin an otherwise artful disclaimer plan are suggested by these questions:

  • Have all state and federal filing requirements been satisfied?
  • Is the interest one which can be disclaimed under applicable state law?
  • Has the disclaimant retained any power or control over the ultimate disposition of the disclaimed assets in a manner which will violate the prohibition against “direction”?
  • Has the disclaimant already accepted “benefits” of any sort in the disclaimed assets?

Yet another factor to determine in advance whether the disclaimer will cause unintended ancillary tax results, as for example under the state’s tax and expense apportionment laws, or the tax or expense apportionment clause in the will or trust itself. This very issue triggered an unanticipated reduction in the amount of the estate tax charitable deduction allowed in PLR 9616001, summarized as the opening example in this article.

In conclusion, despite the need to exercise caution to avoid these and other potential traps and pitfalls, the under-appreciated disclaimer is among the most versatile items in the planned giving officer’s tool kit. The disclaimer’s ability to open exciting new opportunities for effective “after-the-fact” post-mortem charitable planning and reshuffling of troublesome or tax-wasting dispositive schemes makes becoming more familiar with the disclaimer well worth the effort.

IRS Circular 230 Disclosure: To the extent this message contains tax advice, the U.S. Treasury Department requires me to inform you that any such advice, whether in the body of the message or in any attachment, is not intended or written by my firm to be used, and cannot be used by any taxpayer, for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code. Advice from my firm relating to tax matters may not be used in promoting, marketing or recommending any entity, investment plan or arrangement to any taxpayer.

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