Many Wills have been drafted to eliminate the estate tax at the first spouse’s death by (i) funding a credit shelter trust with the maximum amount such that no estate taxes are due and then (ii) leaving the remaining share in a marital (QTIP) trust for the surviving spouse. As recently as 2001, the maximum credit shelter amount was $675,000. For decedents dying in 2004 and 2005, that amount is $1.5 million.
Typically, the credit shelter trust provides for discretionary income and principal distributions to the surviving spouse during her lifetime. At her death, an outright distribution to the children is made. Some credit shelter trusts were not drafted to provide for discretionary distributions to children.
Assume decedent dies in 2004 with an estate worth $5 million, his Will utilizing the pecuniary credit shelter funding mechanism described above, with no discretionary distributions to the children. He is survived by three adult children, ages 48, 50 and 52, and a spouse age 80 in good health. The credit shelter trust will be funded with $1.5 million, and the marital trust with $3.5 million.
The surviving spouse, whose average life expectancy is approximately 9.3 years, will be entitled to all of the income from the marital trust, and will also have a right to discretionary distributions of income and principal from the credit shelter trust. The children will inherit nothing until the death of the surviving spouse.
In this situation, the family may decide that the children should receive some of the decedent’s assets prior to the death of the surviving spouse. One option would be for the surviving spouse to take distributions from the trusts and then make gifts to the children. However, this option has drawbacks: First, the trustee is under a fiduciary obligation to make distributions only for the benefit of the surviving spouse; second, and perhaps more importantly, any gifts by the surviving spouse to her children will incur a gift tax. The gift tax has not been repealed. In fact, the maximum amount which can be gifted before incurring a gift tax liability is $1 million — an amount which is now frozen. Finally, should the surviving spouse die before 2010, her estate could incur a sizeable estate tax.
Another solution could be for the surviving spouse to disclaim all or a portion of what she would take under the credit shelter trust. Many Wills contain a provision allowing a beneficiary to disclaim; however, a valid disclaimer can be made even without such an explicit provision in the Will.
To be effective for state law purposes, EPTL § 2-1.11 provides that “any beneficiary may renounce all or part of his interest [provided] such renunciation shall be in writing . . . and shall be filed in the office of the clerk of the court having jurisdiction over the will . . . within nine months . . . accompanied by an affidavit of the renouncing party that he has not received . . . any consideration . . . for such renunciation.” To be effective for federal tax purposes, IRC § 2518 provides rules similar to EPTL § 2-1.11.
The nine-month period under EPTL § 2-1.11 is rigid but not jurisdictional: a court may extend the time to renounce for reasonable cause. However, the nine-month requirement under IRC § 2518 is jurisdictional. Therefore, if a New York court allows a disclaimer after nine months, it will constitute a gift for federal gift tax purposes. However, the later renunciation would nevertheless be effective as against creditors of the surviving spouse.
To return to the hypothetical, the effect of the renunciation is that the renouncing party is treated as though she predeceased the decedent. It is black letter law that a disclaimant must have no ability to designate who receives the disclaimed property. Thus, the children would each receive outright 1/3 of the cash (or property) which would, but for the renunciation, have funded the credit shelter trust. In this case, each child (or issue if the child predeceased) would receive $500,000.
The advantage of executing the disclaimer is that the children will receive cash at a time when their parent might have wanted them to receive it, and the surviving spouse will still have ample funds with which to maintain her accustomed standard of living. To the extent this money never enters the surviving spouse’s estate, her own estate planning task will be simplified. Both EPTL § 2-1.11 and IRC § 2518 allow the renouncing party to renounce all or part of the interest. The surviving spouse in the example might have renounced only half of the amount that would have funded the credit shelter trust.
A problem frequently encountered with disclaimers involves the requirement that the renouncing person receive no benefit from the renounced interest. A person may not renounce once he has accepted any part of the distributive property. Smith v. City of New York, 344 N.Y.S.2d 799. If the surviving spouse, who might also be the executor, during the time prior to engaging counsel, receives any distribution of property to be renounced, perhaps even of any property in the estate, a later disclaimer may be invalid. It is critical that the estate be left intact until a valid disclaimer is effected. A valid disclaimer may be made before a Will is admitted to probate, and before letters are issued.
Updating a Will drafted when the both the credit shelter amount and the size of one’s estate was more modest is preferable to relying on post-mortem estate planning involving disclaimers for two reasons: First, the potential disclaimant, typically the surviving spouse, may not wish to disclaim; and second, even if she were otherwise favorably disposed to executing a disclaimer, the Will may provide alternate dispositions which do not accord with her own desire as to who should receive the disclaimed property.
Disclaimers can accomplish a variety of objectives. At times, they can be used to fine-tune dispositive Will provisions. Their importance is elevated where they are utilized to make substantive changes to the dispositive scheme where the decedent failed through inadvertence during his lifetime to make those changes.