For federal gift and estate tax purposes, an individual who’s entitled to receive a gift or bequest (inheritance) is presumed to accept the gift or bequest unless it’s expressly disclaimed (refused). For purposes of this article, we’ll call the person who’s entitled to receive the gift or bequest the “intended donee.”
Possible Scenarios for Disclaimers
A gift or bequest may turn out to be ill-advised for various reasons. If so, a qualified disclaimer can potentially be used to correct the misbegotten gift or bequest without adverse tax effects for the disclaimant. (See main article for a full explanation.) Here are some situations — besides when an intended donee simply doesn’t want a gift or bequest — where a qualified disclaimer could be helpful.
Property depreciates in value. Property can sometimes depreciate drastically within the nine-month period for making a qualified disclaimer. Had the donor retained the property, it could have been sold for a tax-saving capital loss. Or if the donor had waited to give away the property, the value of the gift would have been lower for federal gift tax purposes. A qualified disclaimer by the intended donee can effectively erase the gift and put the property back in the hands of the donor with no tax harm done.
Donor remorse. After making a gift, the donor might have regrets for various reasons. If the intended donee will cooperate by making a qualified disclaimer, the ill-considered gift can effectively be erased.
Donee dies unexpectedly. The intended recipient of a gift may die unexpectedly shortly after the gift. Had the donor known that the recipient would die shortly after the gift, the donor wouldn’t have made it. If the executor of the recipient’s estate makes a qualified disclaimer with respect to the gifted property, the gift is effectively negated.
Warning: The executor of the gift recipient’s estate generally has a fiduciary duty to act in the best interests of the estate’s beneficiaries. The executor should determine whether making a qualified disclaimer would violate this fiduciary duty.
For example, Pedro is an avid collector of classic cars. He owns a 1953 Edsel in perfect condition. In August 2022, Pedro gives the beloved car to his son, Alonzo, who’s also an avid car collector. Alonzo’s wife, Bella, doesn’t care about cars, classic or otherwise.
Alonzo dies unexpectedly in October 2022. As the sole heir to Alonzo’s estate, Bella would inherit the Edsel. The executor of Alonzo’s estate is concerned that she’d sell the car and is sure that Alonzo wouldn’t want the car to be sold. After confirming that he wouldn’t be violating any fiduciary duty to Bella under applicable law, the executor makes a qualifying disclaimer of the gift of the Edsel to Alonzo. As a result, Pedro retains ownership of the car.
Unless the intended donee’s refusal to accept a gift or bequest takes the form of a qualified disclaimer, the intended donee is treated as passing along the gift or bequest to the next person in line as a gift. If that happens, it will use up part or all of the intended donee’s unified federal gift and estate tax exemption ($12.06 million for 2022).
In contrast, when the intended donee makes a qualified disclaimer, no gift is deemed to have been made and the intended donee becomes “the disclaimant.” A disclaimant doesn’t use up any of the unified federal exemption by refusing a gift or bequest.
Why Might You Want to Disclaim a Gift or Bequest?
In most circumstances, you wouldn’t want to disclaim a gift or bequest. But, say you’re financially set while your sibling is struggling to make ends meet. You might want to disclaim part or all of a gift or bequest so that your sibling — who’s the next person in line and who really needs it — receives the disclaimed money or asset.
See “Possible Scenarios for Disclaimers” at right for additional situations where a disclaimer might be advisable.
How Do You Make a Tax-Smart Qualified Disclaimer?
If the intended donee of a property interest makes a qualified disclaimer with respect to the property, the property is treated as if it had never been transferred to the disclaimant. Therefore, there’s no federal gift tax, estate tax or generation-skipping transfer tax impact for the disclaimant. Instead, the disclaimed property, which could be cash, is considered to pass directly from the donor (the maker of the original gift or bequest) to the person who has become entitled to receive the property as a result of the qualified disclaimer.
For example, Bill recently lost his mom, Betty, to cancer. Betty’s will bequests $1 million to each of her two sons, Bill and Phil. Bill is set financially, so he decides to make a qualified disclaimer of the cash that he’d otherwise receive from Betty’s estate. That way, his share of the estate will go to his brother Phil who’s the estate’s co-beneficiary, and there would be no impact on Bill’s unified federal gift and estate tax exemption. Phil, who lost his small business during the pandemic, is grateful for Bill’s generosity.
A qualified disclaimer must meet the following five requirements:
- It must be an irrevocable and unqualified refusal to accept an interest in the disclaimed property.
- The refusal must be in writing.
- The written refusal must be given to the donor or other applicable party (such as the executor of the estate that’s the donor) by the applicable deadline.
- The disclaimant must not have accepted any interest in or any benefits from the disclaimed property at the time of the disclaimer.
- As a result of the disclaimant’s refusal, and without any direction from the disclaimant, the disclaimed interest must pass to some other person.
Can You Make a Qualified Disclaimer of a Partial Interest?
The disclaimer of all or an undivided portion of a separate interest in property (severable property) can potentially be a qualified disclaimer even if the disclaimant has another interest in the same property. However, the disclaimed interest must have been created by the donor. The disclaimant can’t be the person who created the separate interest. Severable property is defined as property that can be divided into separate parts, each of which, after severance, maintains a complete and independent existence.
Here are some examples of qualified disclaimers of partial interest severable property:
- Under recently deceased Dad’s family trust, son Brock is to receive 5,000 shares of Alpha Corporation stock. Brock disclaims 2,500 of the shares in favor of his sister Angela, who’s an equal co-beneficiary of Dad’s trust.
- Aunt Sally dies. Her will leaves all of her valuable personal effects — consisting of paintings, antique furniture, jewelry and a coin collection — to her daughter Delaney. Delaney disclaims two of the paintings and all of the jewelry in favor of her sister Grace, who’s entitled under the will to receive whatever doesn’t go to Delaney.
- Dad’s estate leaves a 640-acre farm to his son Ernest. Ernest disclaims 210 identifiable acres in favor of his brother Fritz, who’s entitled under Dad’s will to receive whatever doesn’t go to Ernest.
A disclaimer of an undivided interest in property can be a qualified disclaimer if it otherwise meets the qualified disclaimer rules. An undivided interest must consist of a percentage or fraction of each substantial interest in the property in question. Also, it must extend over the entire term of the interest in the property and in other property into which that property is converted.
For example, Dad gives the income from a farm to his daughter, Beta, for life. The remainder of the income is to go to his grandson, Gamma. Beta disclaims 40% of the farm income in favor of Gamma. Beta’s disclaimer can be a qualified disclaimer if the applicable rules are met.
Can a Disclaimant Direct Who Gets Disclaimed Property?
A disclaimer isn’t a qualified disclaimer unless the disclaimed interest passes without any direction on the part of the disclaimant. A disclaimant is treated as directing the transfer of the disclaimed interest if there’s an express or implied agreement that the interest be given or bequeathed to a person specified by the disclaimant.
Are Verbal Disclaimers Allowed?
A qualified disclaimer must be written and timely. The document needs to identify the interest in property being disclaimed, and the disclaimant or a legal representative must sign it.
What’s the Deadline for Making a Disclaimer?
A disclaimer is a qualified disclaimer only if the required written document is delivered to the donor (or the donor’s representative) by no later than nine months after the later of:
- The day on which the transfer creating the interest is made, or
- The day the disclaimant reaches age 21.
If applicable state law requires that a disclaimer be filed earlier than the aforementioned deadlines, the disclaimer must comply with the earlier state-law deadline to be considered timely for federal tax purposes.
On the other hand, a state-law deadline for disclaiming property won’t extend the federal tax deadline. For example, Texas has no deadline for disclaimers as long as they’re made before accepting the property. However, the nine-month rule still applies for federal tax purposes.
The nine-month period for making a qualified disclaimer is determined with reference to the transfer that creates the disclaimant’s interest in the property. For gifts, a transfer occurs when there’s a completed gift for federal gift tax purposes.
What’s the Tax Impact of a Nonqualified Disclaimer?
Disclaimers that don’t meet the requirements for a qualified disclaimer are treated for federal tax purposes as gifts by the disclaimant to the person who becomes entitled to the property as a result of the disclaimer.
The IRS addressed this issue in Private Letter Ruling 200901013. Here, the children of the settler (creator) of a trust made nonqualified disclaimers of their interests in the trust, which resulted in property passing to the settler’s grandchildren. The IRS concluded that the transfers resulting from the disclaimers were gifts from the children to the grandchildren. So, the children were subject to federal gift tax on the transfers.
For More Information
As you can see, the tax rules for disclaimed gifts and bequests can be complicated. If you have questions about making a qualified disclaimer, contact your tax advisor. Your tax pro can help ensure you meet all the requirements if you decide that a qualified disclaimer is right for your situation.