A key element of estate planning is to remember that ‘things change.’ Assets today might not be available down the road. At the same time, assets might grow and require money to be moved around or reallocated when a spouse passes away.
The best estate planning strategies offer flexibility so loved ones can analyze situations and make decisions. Rather than adhering to stiff plans with complex A/B cost structures, estate planners can add flexibility and achieve maximum tax advantages with qualified disclaimers.
What is a Qualified Disclaimer?
A qualified disclaimer is a refusal to accept property or assets bequeathed in a will or similar document. When the beneficiary of an estate or trust submits a qualified disclaimer, the IRS permits the property to skip to the next person in line. For tax purposes, it is as though the beneficiary never receives any interest in the property.
Several scenarios exist where qualified disclaimers can be beneficial. The beneficiary might not want to inherit money because of outstanding debt or other circumstances that would transfer assets to creditors. They might not need the money because they already have enough assets and prefer children or grandchildren to benefit.
To be valid, a qualified disclaimer must meet the following requirements:
- Must be in writing
- Must be within nine months of the gift
- No acceptance of the gifted interest or any benefits
- Interest passes without any direction on the part of the person making the disclaimer
- Must pass to either the descendant's spouse or to a person other than the disclaimant
When drafting a trust for spouses, qualified disclaimers can be used as a “wait-and-see approach” for when estate taxes may be a future consideration. Disclaimers enable spouses to evaluate estate taxes and family dynamics at the time of death rather than trying to predict the future. They prevent spouses from being handcuffed to decisions and provide marital share distribution flexibility.
How are Disclaimers Set Up in Estate Planning?
Establishing an A/B Trust structure with a qualified disclaimer allows married couples to combine their estate tax exemptions ($5.45 million per individual in 2016) and maximize control of their estate.
In this approach, when one spouse passes away, their estate funds both an A Trust and a B Trust, where any amount disclaimed by the surviving spouse funds the B share for the benefit of their children or other beneficiary. In many cases, the deceased spouse’s tax exemption is utilized for the B Trust.
This approach provides for maximum discretion and distribution flexibility for the surviving spouse from the A Trust. However, the surviving spouse cannot retain limited power of appointment over the disclaimed assets.
When is the Clayton QTIP Election Beneficial?
An alternative strategy is the Clayton Election, which is an adaption of the A/B disclaimer where the surviving spouse can keep power over the bypass trust.
In this scenario, the spouse can elect to treat the B Trust as a qualified terminable interest property (QTIP) trust. A QTIP does not provide estate tax protection but is a more favorable strategy for mitigating capital gains tax. Any portion of your client’s estate not elected to qualify for the estate tax marital deduction funds the bypass trust.
Some of the requirements for a QTIP include:
- Surviving spouse must be the only beneficiary
- All income must be distributed to the surviving spouse every year at a specified interval
- Non-productive property must be allowed to be converted to productive property
- Spouse can keep lifetime powers
When working on marital trust, both qualified disclaimers and Clayton Elections can be advantageous estate planning strategies for maximizing flexibility. A thorough evaluation of client circumstances and goals will help determine which strategy is more beneficial.
