It may sound crazy, but there are lots of reasons why you might want to give your inheritance a second thought before cashing that check. From big family dynasties to simple problems with creditors or tax liens, there are reasons to disclaim that you've probably never thought about, regardless of your situation.
A qualified disclaimer is the legal instrument we use to make sure everybody's taken care of and the deceased's wishes are carried out, without paying huge or double taxes on the estate. Before you find yourself in need of a crash course on the topic at what's bound to be an upsetting time, learn more about disclaimers and why you might want to use them. Here, we'll look at some of the reasons to disclaim an inheritance.
Dynasty Businesses & Shareholders
Things can get tricky when a death interferes with a family business. By using smart disclaimers in conjunction with the will and other legal documents, you can make sure things go the way the deceased would want them to.
For example, say you own half of your husband's stock and then inherit the other half: By disclaiming that bequest and passing it on to your son or daughter, you can make him or her the sole stockholder by selling your own shares.
Or, if there's a shareholder agreement that says only certain people are allowed to own stock, a nonpermitted person inheriting that stock would have to sell immediately. By smart use of disclaimers, you can cause this money to pass to a nonpermitted person, forcing the sale, or to a permitted shareholder, keeping the stock in the family.
Cases of Debt & Bankruptcy
If the deceased is carrying creditors, the inheritance may not be worth the consequences the estate brings along with it. Or, on the other hand, it could be that the beneficiary named in the will has such a massive debt load that any estate passing to him or her would instantly vanish to cover the debt. In order to keep that property in the family, the heir could disclaim and step out of the line of inheritance altogether.
In fact, this is why disclaimers were originally invented. Just remember, you can't benefit in any way from the estate you're disclaiming, and you can't change your mind later. Even simple mistakes, like depositing an interest check in your personal account, could render your disclaimer invalid.
The Applicable Credit
As it stands, you're allowed to inherit or receive gifts of up to $675,000 over your lifetime before those gifts are taxed. That may sound like a lot, but if you consider that you'll inherit your spouse's estate when he or she dies, those numbers can add up quickly.
A decedent's estate could exhaust his surviving spouse's credit, and then it becomes part of her estate. That means that when she passes her estate on to their children, it'll be taxed again. By disclaiming her spousal right to inherit, that estate passes to the next generation tax-free (within their own exemption).
If there's another instrument in play -- for example, the next person in line to inherit is actually a trust -- the survivor can allow the bequest to pass directly into that trust, where it will begin drawing interest.
The Marital Deduction
A surviving spouse can't be taxed on an inheritance, although as we've seen, it does add to the survivor's total estate in terms of the next generation. In order to lessen this future burden, many couples create a marital trust by which the executor can equalize the estates of the decedent and survivor. Estate taxes are calculated on the overall size of what's considered an estate -- which is to say, two smaller estates will be taxed less than one giant estate, even though the monetary value is equivalent. Thus, the tax burden on the next generation is lessened.
But if you don't have a marital trust in place, a smart disclaimer can do the same work. Say a husband passes on without a will in a state where half of his estate automatically goes to his wife and half to his kids. The kids could pay taxes on that money. But if the children file disclaimers on their inheritances, that money goes back to the wife tax-free, because she is now the only beneficiary.
The Generation-skipping Exemption
Another tax right we all have is a $1,010,000 generation-skipping tax exemption, which says that money that comes down to us from ancestors beyond our own parents can't be taxed up to a certain amount. When the adult children of the deceased already have a sizeable estate and don't need the inheritance provided in the will, they can use a disclaimer to pass that money down to the next generation without calling that exemption into consideration.
Since most estate documents on this level of wealth are pretty specific, this might be a case where you disclaim particular bequests, as laid out in the will. As long as the disclaimer is legally qualified and filed in a timely manner, it will be as though the deceased's children never inherited at all. That can have great tax benefits for all three generations.
Correction of Documents
Another common reason to use disclaimers is simply to correct or change a will by realigning what the deceased would have wanted with what the legal documents ended up containing. Maybe circumstances changed, someone got divorced or remarried, or somebody had or adopted a child. Often, we don't think about estate planning when we should (because it's a drag), so those kinds of errors (even typos) sometimes get through.
But by making a few moves with disclaimers, you can set things back on the path your relative would have preferred. For example, even if the husband's will creates a trust for his wife and kids, naming the wife as the executor means she won't get any tax breaks when she passes her estate on to their kids, because it also includes his estate now. By disclaiming her power of appointment, as the person in charge of this trust, she puts things back the way she and her spouse agreed they should be.
The Charity Deduction
It's common to create a charitable remainder trust, which provides for a survivor and sends the remainder of the estate to a charity when the survivor dies. By disclaiming this bequest, the survivor immediately bequeaths the remainder to the charity, meaning the estate gets the full charitable deduction in taxes. Even though you're giving up the cash, this might be better for you (and the estate) down the line.
Even if you're not in this particular situation, remember to check for the next person in line before disclaiming. If the will provides for a charitable donation -- in the case of no living heirs, for example -- the estate will still get the tax break when you take yourself out of the running. This could help you avoid the kinds of taxes that come when you pass your applicable credit, the same way that tax-free spousal inheritance provides its own disclaimer loopholes.
Following the Rules
According to Treasury Regulations, there are a few conditions every disclaimer must follow in order to be considered valid. First, it has to be delivered in writing to the proper estate representative within nine months of the will taking effect.
Also, you can't disclaim just part of a benefit or use any of it before disclaiming -- even just putting the check in your personal account can mean the difference between a qualified disclaimer and a meaningless document.
And finally, you're agreeing to be totally hands-off, no matter what happens next: For the purposes of that bequest, it's like you don't exist. That means you need to know who the next person in line is before you disclaim the benefit in order to keep from creating even more problems.
The issue of corrective disclaimers is especially important right now, given the volatile nature of tax laws in the U.S. You can't know what the circumstances will be when it's time for your survivors to figure out your wishes and untangle your will, so it's best to plan ahead with this in mind.
For the beneficiary, it's also important to remember the financial environment. For example, we used to think that an estate's executor should sell off all investments -- or at least diversify them -- in order to make splitting up the proceeds easier on the family. This was simple, because the worth of investments was calculated and taxed on its original cost.
But now the rules have changed, and we pay income tax on the difference between the two -- which makes it the executor's problem, if we don't consider this fact. The IRS may even assign a starting worth of zero if you can't document the original price, making the whole value one big piece of income. That's no way to treat your heirs!
As you can see, there are many ways a disclaimer might help you keep property in the family or in line with the decedent's wishes. We can't account for every circumstance, and it's possible that some of these considerations might never have come up when planning the estate.
However, by including the possibility of disclaimers when arranging your own affairs, you can prepare for any eventuality. While the estate tax was suspended in 2010, for example, a lot of complicated wills stopped making sense altogether. We never know what's going to happen or when we'll die, which is why we create wills and estate plans in the first place. Making room for disclaimers in our own estates means that whatever tax laws are in effect when we do leave our loved ones behind, they'll be protected.
Check out the links on the next page to learn more about wills and inheritance.
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- Bank of America Corporation. "5 Inheritance Planning Mistakes." Merrill Lynch Wealth Management. 2010. (Jan. 15, 2011)http://www.totalmerrill.com/TotalMerrill/pages/ArticleViewer.aspx?TITLE=5-inheritance-planning-mistakes
- Deathcare.com. "How to Refuse a Bequest". July 30, 2009. (Jan. 15, 2011)http://www.deathcare.com/2009/how-to-refuse-a-bequest.html
- Horovitz, Rudoy & Roteman. "To Disclaim or Not To Disclaim: That Is the Question." Oct. 30, 2006. (Jan. 16, 2011)http://hrrcpa.com/events.php?st=article&title=132
- Jacobs, Deborah L. "Estate Tax's Unclear Fate Challenges Heirs." The New York Times. Feb. 17, 2010. (Jan. 16, 2011)http://www.nytimes.com/2010/02/18/your-money/estate-planning/18ESTATE.html?_r=1
- Jacobs, Deborah L. "Saying 'No Thanks' to a Bequest." The New York Times. Feb. 17, 2010. (Jan. 16, 2011)http://www.nytimes.com/2010/02/18/your-money/estate-planning/18DISCLAIM.html
- Selzer Gurvitch Attorneys at Law. "Just Say No, Thanks - Disclaiming Gifts or Bequests." Feb. 15, 2008. (Jan. 15, 2011)http://www.sgrolaw.com/news_publications/publications-info-24
- TrustLawyer, LLC. "Do You Really Want Your Entire Bequest? Planning with Qualified Disclaimers." Law Office of Jeffrey L. Crown. 2010. (Jan. 15, 2011)http://www.trustlawyer.com/qualified-dis.html