Why the Disclaimer in a Disclaimer Trust can be Magical

If X dies and gives his assets in his Will or Living Trust to Y, his son, the document may say that if Y predeceases X, then the assets pass at X’s death to Z, who is the son of Y and the grandson of X. If Y validly disclaims all or a portion of these assets, they will pass to Z, but Y will not be treated as having made a gift to Z for federal gift tax purposes. Y will not have used up any of his exemption for gifts during life or for gifts at death, because the assets will be treated as passing straight from X to Z (ie by virtue of the disclaimer).

Normally, a person making a disclaimer cannot receive any benefit from the disclaimed (refused) assets. In the above example, Y doesn’t receive any benefit. But a surviving spouse (unlike any other person making a disclaimer) is allowed to receive benefits from the disclaimed assets. In a disclaimer trust, the disclaimed assets move from the revocable survivor’s trust to the irrevocable disclaimer trust. The surviving spouse has unlimited rights in the survivor’s trust, but the survivng spouse can only use the principal of the disclaimer trust for her true needs (health, education, support and maintenance, but NOT comfort).

When  husband (A) dies and the surviving spouse (B) makes a valid disclaimer, B is not treated as having made a gift for gift tax purposes. The assets are treated as having passed straight from A to the disclaimer trust. Because B is the surviving spouse, B can receive benefits from the disclaimer trust. So long as B does not accept the benefits from the disclaimed assets, B can have up to 9 months after A’s death to decide whether or not to disclaim.

By disclaiming, B can protect A’s estate tax exemption (the amount that A could die with and pay no estate tax). During the 9 months, B can look at the size of her own estate, the amount of her own exemption and her own life expectancy. B can wait until A’s death to see whether or not Congress has made permanent the estate tax exemption and/or the portability (the ability to transfer to the surviving spouse) of the first spouse to die’s estate tax exemption.

But the disclaimer trust could not work as it does were it not for the federal tax laws that treat B as having died before A when B makes a valid disclaimer. Stated differently, these laws treat B as NOT having made a gift to anyone when B disclaims because the disclaimed assets are treated as having passed directly from A to the Disclaimer Trust. That is where the magic is.


About randyspiro

I am a super lawyer in California with dual specialization in Estate Planning and Taxation.
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