Disclaimer Trust: Having your cake and eating it too
Consider the following hypothetical: A husband dies, leaving his wife $4 million. Because this is greater than the $2.7 million threshold for estate taxes in Minnesota (in 2019), $1.3 million would be taxed. If the estate tax in Minnesota were 10 percent, that's $130,000 in taxes, and not an insignificant amount. So how could the estate be structured so as to allow the wife to avoid paying taxes on the $1.3 million?
One answer would be to use a disclaimer trust.
What is a disclaimer?
A disclaimer is when a person who is receiving money from an estate decides they do not want it. They “disclaim” the assets. This means that for tax purposes, it is treated as if the person died before the decedent. The assets then pass on to the next beneficiary in line. For example, say a child is to inherit a substantial amount. But the child is already wealthy. They could disclaim the amount and have it pass to the next in line, i.e., their children.
Looking to the prior hypothetical, the will might state as follows: “Funds go to my wife. But if she is no longer alive, then it will pass to our daughter.” So, if the wife disclaims some of the taxable estate, then that amount would go to the daughter.
But what if the wife doesn't want to pay taxes on the $1.3 million, but still wants the money? Can she have her cake and eat it too? Yes, if the will was drafted properly to include a disclaimer trust.
What is a disclaimer trust?
A disclaimer trust is set up in a will or trust. It acts as a “beneficiary” in the line of succession. The will might say, for example, “my estate goes to my wife. But if she does not survive me, then it goes to the disclaimer trust established herein.” If, in the prior hypothetical, the wife disclaims $1.3 million, then it would go into the trust. The wife could then use the funds during her life, and without having to pay estate taxes on the amount. When the wife dies, whatever is left in the trust goes to the next beneficiary. In other words, to the daughter.
The trust acts as a tax shelter. But also, once the money is in the trust, it gives the remaining spouse some protection from creditors. Remember, the trust is a separate entity than the spouse. Creditors of the spouse will not be able to chase the funds in the trust.
When should a disclaimer or disclaimer trust be used?
A disclaimer trust should be used when there is a potential tax savings from doing so. It is that simple.
One thing to keep in mind: there is a danger with remarriage and blended families. Take the above hypothetical. The husband's intent might have been first for his wife to access the money during her life. Second, he could intend the money pass on to their daughter. But what if the wife remarries and has more children? She could change the beneficiaries in the trust so that the remainder goes equally to all her children. Or, she could cut out the daughter entirely. If this is the concern, then it might not make sense to use a disclaimer trust. Instead, one could fund a separate trust for the daughter's benefit, maybe funding it with life insurance.
One other thing to keep in mind: there is a nine-month window to make the disclaimer. If the surviving spouse is not one who would take action in a timely manner, it might be better to use a different strategy to avoid taxes.
Are there other challenges with a disclaimer trust?
In order for a disclaimer trust to be effective, the following requirements must be met:
The disclaimer must be an irrevocable refusal to accept the property.
The disclaiming party cannot receive any benefits from the property before disclaiming it.
The disclaimer must be in writing.
The disclaimer must be made within 9 months of the decedent's death.
The disclaiming party cannot have any say in where the property goes after being disclaimed.
This is a fine time to bring in an attorney to make sure things are properly done.
The takeaway is that there are many creative ways to avoid various taxes during estate planning. It just takes a little knowledge and forethought. Including a disclaimer provision in an estate plan is an easy way to give the surviving spouse some options.
Takeaway
There are numerous ways to structure an estate plan to avoid paying estate taxes. One of those ways is to use a disclaimer trust. They are complicated and do require counsel to set up. If you have questions about disclaimer trusts or need to see if one is right for you, please contact Signature Law for a free consultation.