[This article was originally published by the Real Property, Probate and Trust Law Section of the American Bar Association in Probate and Property, Vol. 1, No. 5, p. 48 (September/October 1987). Changes have been made in the sample will provisions following the article, to reflect the author's current practices, but no additional research has been done to update or confirm any the legal authorities or legal principles. D.B.E. 12/11/96]
Consider the following common estate planning problems:
Situation 1. Husband and wife are both in their thirties or early forties. They are professionals or own their own business, and their incomes and net worth should increase substantially over the next few years. At the moment, taking into account nothing by life insurance, various retirement plans, and the equity in their home, they have combined estates of $600,000 or $800,000. Either of them could inherit a few hundred thousand dollars. Ignoring tax considerations, they would like to leave everything to the survivor and in trust for their children upon the death of the survivor.
Situation 2. Husband and wife are both in their sixties or seventies, recently retired, with grown children. They have cashed in their life insurance, but their combined estates are still about $800,000 to $900,000, taking into account the value of their home and their investments (which are mainly intended to maximize income, and not future growth). Once again, they would like to leave everything to the survivor and to their children upon the death of the survivor.
Although these two situations seem very different, they are actually very similar, because in both cases it might be possible to avoid federal estate tax through a "nonmarital," "by-pass," or "credit shelter" trust. However, in neither case is it clear that a nonmarital trust is now the best course of action.
For the young couple in Situation 1, their present assets and ages do not appear to justify a traditional marital deduction formula and nonmarital trust. Even if their estates should double in value in the next few years (which is likely), it is still not altogether clear that a nonmarital trust is necessary or appropriate. If the surviving spouse has a life expectancy of forty years or more, the projected tax saving upon the death of the surviving spouse becomes highly speculative. If the estate of the surviving spouse does not continue to increase, but instead is consumed and declines in value, or the federal estate tax system is abolished or substantially modified, there may be no estate tax saving at all upon the death of the surviving spouse. In the meantime, you have saddled the surviving spouse with the bother and expense of administering a trust for the rest of his or her lifetime.
There may seem to be a more certain estate tax saving for the elderly couple in Situation 2, but there is still the life expectancy of the surviving spouse to consider (which could be as much as fifteen or twenty years). It seems highly likely that the estate of the survivor will decline in value, rather than increase, and so the projected estate tax saving may disappear within a relatively few years. Thus, solely for tax purposes, the nonmarital trust may not be advisable.
In either case, a nonmarital trust would be much more desirable and the benefits more certain if after the first death it appeared that the surviving spouse had a reduced life expectancy due to a previous accident or illness. Of course, this will not be known until after the first death.
The Internal Revenue Code (the "Code") provides a rather simple and painless estate planning solution for the clients in both situations. Section 2518 of the Code permits the beneficiary of an estate or trust to make a "qualified disclaimer," in which case the disclaimant will be treated, for estate and gift tax purposes, as though he or she had never received any interest in the estate or trust. See Treas. Reg. § 25.2518-1(b). The definition of a qualified disclaimer, in section 2518(b)(4), states that the disclaimed interest must pass without any direction on the part of the disclaimant to either a person other that the person making the disclaimer or the spouse of the decedent. The final regulations confirm that a surviving spouse can, through a qualified disclaimer, allow property to pass to a trust for his or her own benefit. See Treas. Reg. § 25.2518-2(e)(2); Example 4 of Treas. Reg. § 25.2518-2(e)(5).
What is the purpose of a disclaimer by the surviving spouse to a trust for the surviving spouse? The same purpose as a traditional nonmarital trust, to use up the decedent's unified credit and give the surviving spouse the benefit of property without having the property taxed at his or her death. Consider:
The disclaimed property should no longer qualify for the marital deduction, but under the final regulations the surviving spouse could disclaim a fixed dollar amount of the decedent's estate, so that the disclaimer can be structured to use up the decedent's unified credit and not generate any federal estate tax. In fact, an example in the final regulations states that the disclaimer may include a formula, similar to marital deduction formulas now in use, to insure that the disclaimer is of the maximum amount sheltered by the unified credit and does not result in any tax. Example 20 of Treas. Reg. § 25.2518-3(d).
Since the interests of the surviving spouse following the disclaimer are considered to have been created by the decedent and not the surviving spouse, the disclaimed property should be free of tax upon the death of the surviving spouse notwithstanding the "retained" income or other interests of the survivor and notwithstanding Code Section 2036.
We therefore find that we have the ideal solution to many estate planning situations. We can adopt the estate plan desired by the clients, and write wills in which each client leaves his or her entire estate to the survivor. The wills can, however, contain a special clause directing that, if the surviving spouse should for any reason make a qualified disclaimer of his or her interest in the estate, the disclaimed property will pass into a trust for the benefit of the surviving spouse.
In order to make the trust as palatable as possible for the surviving spouse, so that he or she will actually make the disclaimer if tax considerations warrant it, he or she should be given the broadest powers and interests which may be possible without jeopardizing the qualified disclaimer or the estate tax exclusion upon the death of the surviving spouse. The following interests and powers are presently permissible:
The surviving spouse can have all of the income. See Example 4 of Treas. Reg. § 25.2518-2(e)(5).
The surviving spouse can have the power to withdraw the greater of $5,000 or 5% of the principal each year. Example 7 of Treas. Reg. § 25.2518- 2(e)(5). In the sample clause following this article, the power is exercisable only if the survivor is living on the last day of the calendar year, in order to avoid having 5% of the trust included in the taxable estate upon the death of the surviving spouse.
The surviving spouse can serve as the sole trustee, but cannot have any power to direct the beneficial enjoyment of the disclaimed property unless the power is limited by an "ascertainable standard." This is necessary both to qualify the disclaimer and to avoid any taxable general power of appointment. Compare Examples 4, 5, and 6 of Treas. Reg. § 25.2518- 2(e)(5) with Code Section 2041(b)(1)(A). Consider, however, that the Treasury has proposed revoking the "ascertainable standard" exception to the definition of a general power of appointment, and so it might be better to limit invasion powers to a co-trustee to be appointed by the surviving spouse only if the need arises.
The surviving spouse must not have a testamentary power of appointment. See Treas. Reg. § 25.2518-2(e)(2) and Example 5 of Treas. Reg. § 25.2518-2(e)(5).
The wills of both spouses should also include an express authorization for the executor to make qualified disclaimers, so that the estates may be "equalized," and both unified credits used, if they should die simultaneously or within nine months of each other. An express authorization may eliminate obstacles or uncertainty under state laws regarding disclaimers by fiduciaries.
Following this article is a sample disclaimer trust using these guidelines. Through these kind of provisions, we can effectively postpone the marital deduction decision until the death of the first spouse. Upon the first death, we can re-examine the entire situation and advise the surviving spouse whether or not a nonmarital trust is advisable for estate tax purposes. If a nonmarital trust is advisable, the surviving spouse can make an appropriate disclaimer and, in effect, create a trust for his or her own benefit which is not subject to federal estate tax upon his or her death.
This represents an extremely flexible estate plan, and should be considered in all "medium" sized estates, as well as smaller estates which have the potential to become larger estates.
ITEM _____: DISCLAIMERS BY BENEFICIARIES
Notwithstanding the provisions of the preceding Item [spendthrift clause], any beneficiary may, at any time or times, disclaim any interest in my estate, or may disclaim any portion of any such interest, as follows:
A. Each disclaimer shall be in writing and shall be delivered to my executors. A disclaimer by the personal representative of a deceased beneficiary, the properly authorized attorney-in-fact of a beneficiary, or the guardian of a minor or incompetent beneficiary shall have the same effect as a disclaimer by the beneficiary.
B. The disclaimed interest shall be disposed of, and the provisions of my will which relate to the disclaimed interest shall be administered, as though the beneficiary did not survive me. However, if my spouse should disclaim any part of my residuary estate, and if the disclaimer is a "qualified disclaimer" within the meaning of Section 2518 of the Internal Revenue Code, the part which my spouse disclaims shall be held in a separate trust and administered and disposed of as follows:
1. I appoint my spouse to serve as the trustee of this trust. My spouse may at any time or times appoint an individual, bank, or trust company to serve as co- trustee, or to serve as the sole trustee if my spouse has failed or ceased to serve as a trustee. If my spouse and the last trustee appointed by my spouse should both fail or cease to serve, and if my spouse should then fail to appoint a successor trustee, I appoint as trustees the same persons I have appointed as executors in Item ________. Whenever appropriate, the provisions of my will which apply to my executors shall also apply to my trustees, including (but not limited to) the provisions for the powers of my executors.
2. All of the net income shall be distributed to my spouse, or applied for the benefit of my spouse, in quarterly or more frequent installments.
3. If my spouse is living on the last day of a calendar year, my spouse shall have the noncumulative right, exercisable by written notice delivered to the trustees at any time during the calendar year, to withdraw from the trust principal an amount not exceeding the greater of $5,000.00 or five percent of the value of the trust principal on the last day of the calendar year.
4. My trustees may distribute to my spouse, or apply for my spouse's benefit, as much of the principal of this trust as the trustees other than my spouse, in their sole discretion, from time to time consider advisable for my spouse's health, maintenance, and support. It is my intention that no principal be distributed to or for my spouse under the preceding sentence while my spouse is serving as the sole trustee.
[Or: My trustees shall distribute to my spouse, or apply for my spouse's benefit, as much of the principal of this trust as is necessary from time to time for my spouse's health, maintenance, and support.]
5. Upon the death of my spouse, the principal and any undistributed income then remaining shall be distributed to my issue then living, per stirpes.
[Or: Upon the death of my spouse, the principal and any undistributed income then remaining shall be divided into as many equal shares as there are children of mine then living and children of mine then deceased who have left issue then living. The share of each living child shall be held in a separate trust for that child in accordance with the provisions of paragraphs A through __ of Item _________, and the share of each deceased child shall be disposed of in accordance with the provisions of paragraph __ of Item ______.]
[Or: Upon the death of my spouse, the principal and any undistributed income then remaining shall be added to the Nonmarital Trust established under Item ________ of my will, to be held, administered, and disposed of in accordance with all of the provisions of that trust, as though the principal and undistributed income of this trust had been held in that trust at my spouse's death, except that my spouse shall have no power of appointment over any principal or income of this trust.]
ITEM ________: DISCLAIMERS BY EXECUTORS
My executors are authorized to disclaim any interest in property, or to transfer any interest in property, without court approval, provided only that each disclaimer or transfer is a "qualified disclaimer" within the meaning of Section 2518 of the Internal Revenue Code. My executors shall have no liability to any beneficiary of my estate for any consequence of any qualified disclaimer made in good faith, or for any failure to make any qualified disclaimer for any reason.
Evans Law Office
Daniel B. Evans,
Attorney at Law
P.O. Box 27370
Philadelphia, PA 19118
Telephone: (866) 348-4250
Email: dan@evans-legal.com