Disclaimers are sometimes central to good charitable gift planning. They’re handy in various situations. For example, say a donor leaves real estate or tangible personal property to a charity that doesn’t want it. A disclaimer by the charity, assuming it doesn’t cause intolerable problems with the donor’s family, is the obvious course of action.
There’s an interesting tax question about the disclaimer I’ve just suggested. If the disclaimer satisfies applicable local law but doesn’t meet the definition of a “qualified disclaimer” for federal tax purposes (as discussed below), can the donor’s estate claim a federal estate tax charitable deduction with respect to the disclaimed asset? Let’s call this the “initial question.” I’ll discuss it after laying out the requirements and consequences of a qualified disclaimer.
Planning Failure—TAM 8730004
Technical Advice Memorandum 87300041 provides an example of how a post-mortem qualified disclaimer would have made good tax sense.
The pertinent facts are that the husband (H) died, leaving millions of dollars to a charitable remainder unitrust (CRUT) that was to make a payout to his wife (W) and then to his brother (B), if B survived W. Apparently at the time H died, W was in her early 60s and in good health; B was in his 80s and not in good health. So, the chances that B would survive W were slim.
The CRUT, as drafted, was perfectly good as a charitable remainder trust (CRT). There was just one problem. B’s presence as a successor beneficiary disqualified W’s interest in the CRUT for the estate tax marital deduction. Why? Internal Revenue Code
Section 2056(b)(8)(A) provides:
If the surviving spouse of the decedent is the only beneficiary of a qualified charitable remainder trust who is not a charitable beneficiary ... paragraph (1) shall not apply to any interest in such trust which passes or has passed from the decedent to such surviving spouse.2
This language means that H’s estate would have been entitled to claim an estate tax marital deduction with respect to W’s interest in the CRUT if W had been the only non-charitable beneficiary of the trust. By adding B as a successor beneficiary, H forfeited the marital deduction.3
H didn’t know he was doing this, of course, but the lawyer who drafted H’s will should have known. After H died, there was still a way to salvage a marital deduction with respect to W’s interest in the CRUT. That was for B to make a qualified disclaimer, in accordance with IRC Sections 2518 and 2046, of his interest in the trust. I understand from someone close to this situation that a qualified disclaimer wasn’t made because the lawyer didn’t understand there was a marital deduction problem until well after the time for making a qualified disclaimer had passed.4
If B had made a qualified disclaimer of his interest in the CRUT, H would be deemed never to create B’s interest in the trust, and B wouldn’t be deemed to make a transfer for gift tax purposes. IRC Section 2518(b) sets forth the requirements of a qualified disclaimer for estate, generation-skipping transfer and gift tax purposes:
(b) Qualified disclaimer defined
For purposes of subsection (a), the term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if:
(1) such refusal is in writing,
(2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of:
(A) the day on which the transfer creating the interest in such person is made, or
(B) the day on which such person attains age 21,
(3) such person has not accepted the interest or any of its benefits, and
(4) as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either:
(A) to the spouse of the decedent, or
(B) to a person other than the person making the disclaimer.
For purposes of the 9-month requirement of Section 2518(b)(2), the “day on which the transfer creating [B’s] interest” was the date of H’s death. If B had made a qualified disclaimer, his interest in the CRUT would have passed to the charitable remainder beneficiary of the trust—“a person other than the person making the disclaimer,” in accordance with Section 2518(b)(4)(B).5
The Initial Question
The initial question is whether the donor’s estate may claim a federal estate tax charitable deduction with respect to property bequeathed to charity if the charity makes a disclaimer of the bequest that satisfies local law but isn’t a qualified disclaimer for federal tax purposes. The answer logically but oddly appears to be yes, because the property would be deemed, under a straightforward reading of the qualified disclaimer rules, to pass from the decedent to the charity.6
Individuals and their advisors shouldn’t make too much of this apparent anomaly, however. A disclaimer made by a charity that serves no purpose other than to save estate taxes with respect to disclaimed property that passes to the donor’s heirs may call the charity’s exempt status into question. Furthermore, if the charity is a private family foundation (PF), such a disclaimer may be an act of self-dealing under IRC Section 4941.
Good Post-Mortem Planning
Private Letter Ruling 200204022 provides a good lesson in post-mortem charitable gift planning.7 The basic facts are that H and W used assets they co-owned equally to create a CRUT that was to make its payout jointly to H and W and then to the survivor, and on the death of the survivor of H and W, was to make its payout jointly to daughter (D) and son (S) for life. H reserved the right exercisable by will to revoke D’s and S’s survivorship interests in the one-half share of assets H transferred to the CRUT, and W did the same as to the one-half share she transferred.8 The PLR doesn’t address the fact that on creation of the CRUT, H and W made gifts to each other or the fact that these gifts likely didn’t qualify for the gift tax marital deduction because of D’s and S’s contingent interests in the CRUT.9
The PLR instead deals with the fact that when W died, survived by H and their children, without having revoked the children’s interests in the CRUT as to the one-half share of assets W transferred to the CRUT, H’s survivorship interest in that one-half share didn’t qualify for the estate tax marital deduction. Reason: As discussed above, H wasn’t the only non-charitable beneficiary of the CRUT.
A solution to the marital deduction problem was at hand, however. It involved several steps, which brought a state court and local law into play:
• The CRUT was divided into two equal-sized and identical CRUTs: CRUT 1 and CRUT 2.
• CRUT 1 and CRUT 2 were identical in their provisions to the CRUT.
• Half of the CRUT assets was transferred to CRUT 1, corresponding to W’s original funding share. The payout beneficiaries of CRUT 1 were H, D and S.
• The other half of the assets was transferred to CRUT 2, corresponding to H’s original funding share. The payout beneficiaries of CRUT 2 were H, D and S.
• The federal estate tax marital deduction for H’s interest in CRUT 1 was in jeopardy.10 So, D and S made qualified disclaimers of their interests in CRUT 1. As a result, they were treated as having pre-deceased H, meaning H’s interest in CRUT 1 now qualified for the federal estate tax marital deduction. The Internal Revenue Service blessed this whole arrangement.
Flawed Planning in Christiansen
The 2008 Estate of Helen Christiansen case instructs one in the niceties of the qualified disclaimer rules in connection with testamentary charitable giving.11
Helen Christiansen died owning cash, real estate and a 99 percent interest in each of two family limited partnerships (FLPs) she’d created. She left everything to her daughter, Christine, with the proviso that any amount Christine disclaimed would go: (1) 75 percent to a charitable lead annuity trust (CLAT), and (2) 25 percent to a PF (an IRC Section 501(c)(3) charitable organization). Applying substantial discounts to the values of Helen’s FLP interests, Helen’s executor valued Helen’s estate at a little more than $6.5 million. Subsequently, the IRS and Helen’s executor settled on a value of more than $9.5 million for the estate.
Before the settlement was reached, Christine disclaimed all but $6.35 million of the assets left to her. The disclaimer caused: (1) $121,667.20 to flow into the CLAT, and (2) $40,555.80 to flow into the PF. After Helen’s estate was revalued to $9.5(+) million, the disclaimer caused a total of: (1) $2,421,671.95 to flow into the CLAT, and (2) $807,223.98 to flow into the PF.
One can imagine that at this point, Christine and her tax advisors must have felt pretty good. The IRS had prevailed on the FLP valuation dispute, but that meant more went to charity, and correspondingly, there would be a larger estate tax charitable deduction for Helen’s estate.12 Would be, that is, if the increased estate tax charitable deduction was allowed.
That brings us shortly to the focus of this case, the CLAT and the disclaimer applicable to the CLAT. The CLAT was to make a 7 percent payout to the PF for 20 years and then distribute all of its assets to Christine if she was then living. The court characterized Christine’s interest in the CLAT as a “contingent remainder interest.” Christine didn’t explicitly disclaim this remainder interest, and Helen’s estate didn’t claim any deduction with respect to this interest. But, Helen’s estate did claim a charitable deduction with respect to: (1) the value of the annuity payout from the CLAT to the PF, and
(2) the amount passing outright to the PF as a result of Christine’s disclaimer.
Assets passing outright to the PF: The IRS disputed, on public policy grounds, the estate tax charitable deduction Helen’s estate claimed with respect to the extra assets passing outright to the PF as a result of the increased valuation settlement. The IRS maintained it was just wrong to try to freeze the value of an estate that way. It accepted, however, that Christine had made a qualified disclaimer as to the “initial” assets of $40,555.80 passing to the PF. The IRS also challenged the estate’s claim of a charitable deduction as to the CLAT payout, maintaining Christine didn’t make a qualified disclaimer with respect to the assets passing to the CLAT.
The court ruled that Christine made a qualified disclaimer of all the assets passing outright to the foundation and that public policy wasn’t violated by allowing an estate tax charitable deduction for the full value of these assets. The court reasoned that because the estate tax charitable deduction related back to the date of Helen’s death, and because the disclaimer and the estate revaluation both related back to that same date, it was perfectly in accord with the law to allow an estate tax charitable deduction with respect to the amount passing directly to the PF as a result of the revaluation. Thus, the estate freeze strategy worked as to the disclaimed assets that went directly to the PF.
Assets passing to the CLAT: As for the CLAT, the court said it’s clear the estate could have claimed an estate tax charitable deduction for the value of the CLAT payout if Helen herself had left assets by will directly to the CLAT.13 The assets passing to the CLAT, however, passed via a disclaimer, and so, according to the court, the availability of an estate tax charitable deduction for the CLAT payout was governed by the qualified disclaimer rules (not the usual charitable deduction rules of IRC Section 2055) and turned on whether Christine had made a qualified disclaimer with respect to the assets passing to the CLAT.
The court begins its analysis of this matter by positing that Christine, by retaining a contingent remainder interest in the CLAT, made a partial failure of disclaimer with respect to the assets passing to the CLAT.14 The court then turned to the regulations dealing with partial disclaimers (that is, disclaimers of partial interests).15
Under Treasury Regulations Section 25.2518-3, there are two different kinds of partial disclaimers that satisfy the qualified disclaimer rules.
The first is a disclaimer of assets that are “severable.” For example, a disclaimant is left 1,000 shares of ABC stock and disclaims 700 shares. The disclaimed shares are severable in that each of the disclaimed shares is a complete item of property. Christine appears to have made such a disclaimer as to the cash and FLP units passing directly to the PF.
The second kind of partial disclaimer that can lead to an estate tax charitable deduction is one of an “undivided portion” of assets. The court analogizes this kind of disclaimer to the slicing of a lemon meringue pie. A horizontal slice of the pie, which merely skims off the meringue, isn’t an undivided portion. An undivided portion is a piece that contains all parts of the pie. A vertical slice that serves up meringue, lemon filling and crust in one classic piece is an undivided portion; it contains the same proportion of each element of the pie. The court ruled that by keeping the contingent remainder in the CLAT, Christine in effect made a horizontal slice with respect to the assets passing to the CLAT and that this horizontal slice didn’t satisfy the qualified disclaimer rules.16
It’s important to understand that although the qualified disclaimer rules don’t allow for a horizontal slice, such a slice (here, a guaranteed annuity interest in a CLAT) can qualify for an estate tax charitable deduction under Section 2055 for assets actually left by will. Thus, to rely on a qualified disclaimer to get estate assets to charity is to rely on a relatively restrictive provision of the estate tax law.
The savings clause in Christine’s disclaimer: Christine’s disclaimer contained a “savings clause” that the court had to address:
... to the extent that the disclaimer set forth above in this instrument is not effective to make it a qualified disclaimer, Christine Christiansen Hamilton hereby takes such actions to the extent necessary to make the disclaimer set forth above a qualified disclaimer within the meaning of
section 2518 of the Code.17
The court had no difficulty disposing of the savings clause. If the clause were read to mean Christine would disclaim her contingent remainder interest if and when her original disclaimer were determined not to be a qualified disclaimer, the subsequent disclaimer would fail the 9-month requirement of Section 2518(b)(2). If the clause were read to mean Christine would disclaim her contingent remainder interest pursuant to the original disclaimer if it became necessary to make the original disclaimer a qualified disclaimer, the original disclaimer would hinge on the court’s decision and thus wouldn’t be an “unqualified refusal ... to accept an interest in property,” as required by Section 2518.
Christiansen in Retrospect
Christiansen is an important case because it teaches how qualified disclaimers can and can’t work in the context of a charitable estate freeze plan—a plan that seeks to nullify an upward adjustment in estate value by causing the increased value to go to charity, thereby causing an increased estate tax charitable deduction. In retrospect, Helen arguably would have done better to: (1) leave a specific dollar amount to Christine and the balance of her estate to the CLAT and the PF, and (2) provide in her will for an adjustment between the parties in the case of an asset revaluation for federal estate tax purposes, as was done successfully in Estate of Anne Y. Petter.18
Christine was deemed not to have made a qualified disclaimer with respect to the assets passing to the CLAT. Therefore, for transfer tax purposes, Christine was considered: (1) to have received those assets from Helen, and (2) then to have transferred the assets to the CLAT.19
Given that Christine was deemed for federal gift and estate taxes purposes to fund the CLAT, was she also deemed to fund the CLAT for federal income tax purposes?20 If the answer is yes, the CLAT might well be a grantor trust, which might both please and displease Christine.21
Christiansen doesn’t address this question. The question is valid in my opinion, given that the qualified disclaimer rules do have income tax consequences in certain circumstances.22 If I had to guess, I’d say the CLAT is a grantor trust, although the mantra that the gift tax and the income tax aren’t in pari materia (not of the same subject matter, not to be construed together) would preclude my placing a bet either way.
Foundation Planning Considerations
PFs: A common estate-planning fact pattern is that parent (P) leaves wealth by will to child (C), who disclaims, so that the wealth passes pursuant to P’s will to a PF. P or C might have created the PF.
For C’s disclaimer to be a qualified disclaimer, the assets disclaimed must pass to a person other than C without any direction on C’s part.23 To satisfy this requirement, if C sits on the PF’s board, it may be necessary to: (1) place the disclaimed assets in a segregated PF account, and (2) amend the PF’s bylaws to ensure that only an independent trustee has the power to direct distributions out of the segregated account.24
Community foundations (CFs): Disclaimers resulting in assets passing to a donor-advised fund (DAF) at a CF are subject to more relaxed rules. Here, the disclaimant may hold advisory rights with respect to the DAF, because such advisory rights represent a wish, not a command.25
Situation for Discussion
H dies and leaves by will $10 million to a qualified terminable interest property (QTIP) trust for W. H’s will provides that on W’s death, all the QTIP assets shall go to charity and that if W predeceases H, the full
$10 million shall go directly to charity. W executes a timely disclaimer as to $1 million of the QTIP trust’s assets. The disclaimer satisfies local law and is intended to be a qualified disclaimer under IRC Section 2018. Under local law, disclaimed assets are deemed to pass as though the disclaimant pre-deceased the transferor of the assets. Thus, $1 million is carved out of the estate assets destined for the QTIP trust and distributed to charity.
1. Can H’s estate claim a federal estate tax charitable deduction with respect to the $1 million distributed to charity?
2. If for some reason W’s disclaimer isn’t a qualified disclaimer, can W claim a federal income tax charitable deduction with respect to the $1 million distributed to charity?
There’s no case, ruling or regulation directly on point, but this is how I answer the questions:
1. The answer to Question 1 is certainly yes, given the facts, assuming W’s disclaimer is a qualified disclaimer. There’s no reason, based on the facts posed, to believe it isn’t. W can, of course, disclaim her right to receive benefits with respect to a specific portion of assets destined to fund the QTIP trust.
2. The answer to Question 2 is in my estimation, no. Reason: W never holds legal title to, or gains possession of, the assets disclaimed. At least the disclaimant in Christiansen had the right to physical possession of and had legal title to the disclaimed property immediately before making the disclaimer.
There’s possibly a way, however, to re-fashion H’s estate plan so that W can get a federal income tax charitable deduction. To do that, H’s will should provide that any QTIP assets W disclaims shall go to W and for W, having made a qualified disclaimer, to give the assets she receives to charity. The disclaimer arguably can be a qualified disclaimer, resulting in a marital deduction for H’s estate with respect to the disclaimed assets, because Section 2518 provides that disclaimed assets may pass to the transferor’s spouse.26
1. Technical Advice Memorandum 8730004 (April 15, 1987).
2. This language, which is in effect as this article is being written (Summer 2017), was in effect for purposes of TAM 8730004. It came into the Tax Code under the 1981 Tax Act.
3. The loss of the marital deduction in TAM 8730004 is more devastating potentially than may appear at first glance. If the result were that substantial, increased estate taxes were imposed on Husband’s (H’s) estate and the estate lacked the funds to pay these taxes, the Internal Revenue Service could raid the trust to collect the taxes, which would disqualify the trust as a charitable remainder trust (CRT) and potentially knock out any estate tax charitable deduction claimed with respect to the trust.
4. As I understand, the lawyer not only drafted H’s will, but also, he handled the settling of H’s estate. That suggests to me that when the stakes are high and the tax issues are complex, particularly with respect to charitable gift planning, the drafting of the will and the settling of the estate ought to be handled or at least reviewed by two different lawyers.
I’ve been asked whether Wife (W) had recourse against the lawyer. Under traditional common law, W wouldn’t have recourse, because of lack of privity, unless W had a client relationship with the lawyer with respect to the writing of H’s will or the settling of H’s estate.
5. The proof that Brother’s (B’s) disclaimer of his interest in the trust would cause the interest to pass to the charitable remainder beneficiary lies in the fact that the actuarial present value of the remainder interest would increase as a result of the disclaimer.
A question arises as to whether B’s disclaimer could be a qualified disclaimer if it was induced by a promise by W to make a gift to B. I believe the disclaimer could be qualified, because B’s disclaimer wouldn’t constitute the transfer of a property interest to W in consideration of W’s gift.
6. See Treasury Regulations Section 20.2055-1(a) as to this basic requirement for an estate tax charitable deduction.
7. Private Letter Ruling 200204022 (Oct. 22, 2001).
8. H and W reserved the right, exercisable by will, to revoke the survivorship interests of Daughter (D) and Son (S) so that neither H nor W would be deemed to make gifts to D or S for federal gift tax purposes.
9. The gift tax marital deduction rule as to CRTs under IRC Section 2523(g) is the same as the rule that exists for estate tax purposes under IRC Section 2056(b)(8).
10. The marital deduction for charitable remainder unitrust 1 was in jeopardy for the same reason the marital deduction was jeopardized in TAM 8730004, supra, note 1.
11. Estate of Helen Christiansen, 130 T.C. No. 1 (2008).
12. The disclaimer was designed to thwart, at least in large part, an upward revaluation of Helen’s estate by the IRS, by causing all upward revaluation to flow into the charitable lead annuity trust (CLAT) and the private foundation, the intention being that the resulting increased estate tax charitable deduction would shield the asset flow from tax.
13. In the estate tax charitable deduction section, IRC Section 2055, one finds a “partial interest” rule, which allows a charitable deduction for certain partial interests, including the guaranteed annuity interest in a CLAT. In the qualified disclaimer section, IRC Section 2518 and the corresponding regulations (made applicable for estate tax purposes by IRC Section 2046), one also finds a partial interest rule, but it’s a much more restrictive rule.
14. For the definition of a partial failure of a disclaimer, see Treas. Regs. Section 25.2518-2(e)(3).
15. The regulation section that defines “partial failure of a disclaimer,” Treas. Regs. Section 25.2518-2(e)(3), refers to “severable property” and to ”an undivided portion of the property.” These terms are defined, respectively, in Treas. Regs. Sections 25.2518-3(a)(1)(ii) and 25.2518-3(b).
16. The court’s majority focused on the assets passing to the CLAT. The majority said Christine’s disclaimer resulted in a gift to charity, for sure, but allowed Christine to keep a contingent remainder interest in the assets passing to the CLAT. The gift to charity was thus a “horizontal slice.” The dissent focused on the CLAT and pointed out that Christine neither retained nor otherwise had any interest in or affecting the CLAT’s annuity payout.
17. See supra note 11, at p. 8.
18. The suggested estate freeze approach was employed successfully in Estate of Anne Y. Petter v. Commissioner, 653 F.3d 1012 (9th Cir. 2011).
19. Presumably, Christine was entitled to claim a federal gift tax charitable deduction under IRC Section 2522 for her deemed transfer to the CLAT.
20. There’s no qualified disclaimer provision for federal income tax purposes. It’s a transfer tax provision.
21. The CLAT might be a grantor trust under IRC Section 673(a) if the initial value of Christine’s contingent remainder exceeded 5 percent of the amount she was deemed to transfer to the trust. Might, that is, if Christine were considered the trust’s grantor for federal income tax purposes. If she were, she would be able to claim a federal income tax charitable deduction for the initial present value of the CLAT payout (which would be good), but she would have to report all the CLAT’s taxable income on her own return (which might not be good).
22. For example, in PLR 90319029 (May 14, 1993), H died, leaving his profit-sharing plan to W. W made a qualified disclaimer, a disclaimer valid under applicable state law, of 44.3 percent of her interest in the plan. The disclaimed interest passed to her children. The IRS ruled that the income distributions received by the children with respect to the disclaimed interest weren’t includible in W’s income for federal income tax purposes, as they would have been had she not made the disclaimer.
23. See, for example, PLR 9320008 (May 21, 1993).
24. See, for example, PLR 9317039 (April 30, 1993).
25. PLR 9532027 (Aug. 11, 1995).
26. For this plan to work, H’s will needs somehow to override the local law that provides disclaimed assets shall pass as if the disclaimant predeceased the transferor. Perhaps what would work is a provision in H’s will that any qualified terminable interest property trust assets W disclaims shall pass to W or W’s estate if W in fact survives H.