DISCLAIMER


Disclaimer is an estate- and tax-planning tool that allows a disclaimant to avoid accepting property from a decedent and allows that property pass to the next person in line for the property, as if the disclaimant had predeceased the decedent. Generally, anyone who is to receive property, whether through a testamentary or non-testamentary transfer, may disclaim it before acceptance.


The basic policy rationale behind disclaimer is that an heir, recipient of property, or beneficiary should not be forced to accept property or interests from a decedent simply because those interests were intended by the decedent or donor to be devised to that person. Under federal law, disclaimer can also be an effective means of transferring property without having to pay applicable federal taxes. A person might want to disclaim property for the following reasons:

  • Enables the disclaimant to avoid paying property taxes, federal gift taxes, and generation-skipping transfer taxes on the disclaimed property;



  • Allows a surviving spouse to take better advantage of the deceased spouse's disclaimed qualified plan benefits and IRAs;



  • Preserves disclaimed property from a disclaimant's creditors;



  • Avoids spendthrift limitations; and



  • Allows additional post-mortem estate planning for changed circumstances.

While the rationale and effect of disclaimers are the same in Illinois, Indiana, and Wisconsin, there are procedural differences in each state's governing statutes. Due to the variation of standards governing disclaimer between the states, Congress enacted Internal Revenue Code Section 2518 in the Tax Reform Act of 1976 to create a uniform federal standard for disclaimers that qualify for federal estate and gift tax exemption. 26 USC § 2518.


If a disclaimer is "qualified" under Section 2518, then the disclaimant is exempt from paying federal taxes on the transfer of the property or interest that would have otherwise been required by law, for example, as a gift to someone else. In the event the property is not properly disclaimed, the interest will then pass to the disclaimant. The requirements for aqualified disclaimer- as well as for a valid disclaimer - in Illinois, Indiana, and Wisconsin are outlined below.

Rules of Disclaimer


Illinois, Indiana, and Wisconsin have statutes devoted to describing the proper way to disclaim property in each state. There are several similarities and differences among them, and to reap the full benefits of disclaimer, it is essential to know and comply with the state and federal tax law of disclaimer.

Who May Disclaim?


Generally, any grantee, heir, devisee, or personal representative thereof has the right to disclaim. The following is a nonexclusive list providing some examples of who may disclaim property or interests themselves or on the behalf of others:

  • Spouses. See Boatmen's Nat. Bank of Bellville v Direct Lines, Inc., 167 Ill 2d 88, 656 NE2d 1101, 212 Ill Dec 267 (Ill 1995).



  • On behalf of a decedent or ward by a personal representative. See In re Estate of Heater, 266 Ill App 3d 452, 640 NE2d 654, 203 Ill Dec 734 (4th D 1994); 755 ILCS 5/2-7(a).



  • Debtors, in some circumstances, depending on the type of debt and creditor. See Tompkins State Bank v Niles, 127 Ill 2d 209, 537 NE2d 274, 130 Ill Dec 207 (Ill 1989) (holding that the creditors of a devisee cannot enforce their claims against property devised if the devisee has disclaimed the interest). But see, Drye v United States, 528 US 49, 145 L Ed 2d 466, 120 S Ct 474 (1999) (finding that an insolvent heir to a decedent's estate's disclaimer could not defeat federal tax liens because the disclaimant exercised the threshold amount of control for federal tax purposes over the property in disclaiming it).



  • Trustees, under certain circumstances. See, Cleaveland v United States, 62 AFTR2d 88-5992, 88-1 USTC P 13, 766 (CD Ill 1988) (holding trustee's disclaimer valid in particular because the property was to pass with no direction given on the part of the trustee); but see, Rev. Rul. 90-110 (Dec. 24, 1990) (finding trustee's disclaimer was not valid for federal tax purposes because the disclaimer was invalid under state law).



  • Joint tenants, under certain circumstances. See, Indiana Dept of State Revenue v Estate of Parker, 485 NE2d 1387 (Ind Ct App 1985); IC 32-17.5-2-8; 755 ILCS 5/2-7(e)(2).



  • Fiduciaries that do not retain complete power to direct the enjoyment of the claimed interest. 26 USC § 2518-2(d)(2); IC 32-17.5-2-5; IC 32-17.5-3-2.



  • An attorney in fact under a durable power of attorney. Wis. Stat. § 854.13(2)(f).



  • Court-appointed conservator or guardian ad litem. Wis. Stat. § 854.13(13)(2)(e).

Illinois - Any grantee, heir, or devisee has the right to disclaim. 755 ILCS 5/2-7. Additionally, a representative of a decedent or ward may disclaim on behalf of that person with leave of a court of competent jurisdiction, which is commonly the court in which the estate of the decedent is administered or where it would be administered, or if a will or other instrument signed by the decedent or ward specifically authorizes the representative to disclaim without court approval.Id.


Indiana - A person "to whom a disclaimed interest or power would have passed had the disclaimer not been made" may disclaim the interest. IC 32-17.5-2-2. In addition, a personal representative, guardian, or conservator may disclaim on behalf of that person.


Wisconsin - Similarly, a person has the right to disclaim property if the person is an "heir, recipient of property, or beneficiary under a governing instrument, appointee under a power exercised by a governing instrument, taker in default under a power created by a governing instrument or person succeeding to disclaimed property." Wis. Stat. § 854.13.

What Can Be Disclaimed?


Property of either testamentary or non-testamentary transfers may be properly disclaimed. The following is a list of some interests that may be disclaimed:

  • A whole or a portion of an entire interest may be disclaimed in Indiana, Illinois, or Wisconsin. 755 ILCS 5/2-7(a); IC 32-17.5-3-1; Wis. Stat. § 854.13(2)(c).



  • A power of appointment. IC 32-17.5-3-1.



  • A pecuniary amount, as long as no benefit of the disclaimed amount runs to the disclaimant. PLR 8539004 (May 18, 1985).



  • A surviving joint ownership interest. IC 32-17.5-5-1.



  • A life estate interest. In re Aylsworth's Estate, 74 Ill App 2d 375, 386, 219 NE2d 779, 785 (Ill App Ct 1966) (holding that disclaimer by life tenant of life estate interest was valid).

What Must a Disclaimant Do?

Illinois -A disclaimant must "deliver [a written disclaimer document] to the transferor or donor or his representative, or to the trustee or other person who has legal title to the property, part or interest disclaimed . . ." 755 ILCS 5/2-7(c). The form of the disclaimer "shall (1) describe the property or part disclaimed, (2) be signed by the disclaimant or his representative and (3) declare the disclaimer and the extent thereof." 755 ILCS 5/2-7(b). There is no set time limit in which the disclaimant must disclaim the property or age requirement of the disclaimant; however, the disclaimant must disclaim before acceptance of the property. Additionally, the disclaimer must be irrevocable and binding.

Indiana -Since the passage of the Uniform Disclaimer of Property Interests Act in Indiana, the provisions concerning what a disclaimant must do to disclaim property are essentially the same in Indiana as they are in Illinois. IC 32-17.5.

Wisconsin -Wisconsin's requirements are similar as well, with the addition of a provision that the property must be disclaimed within a nine-month window, although that time frame may be extended by a court of competent jurisdiction for cause. Wis. Stat. § 54.13(4)-(4)(a).

Qualified Disclaimer and the IRS


Meeting the requirements of disclaimer under the applicable state law ensures that the property is disclaimed. In most cases though, to take advantage of the tax benefits of disclaimer, the disclaimer must also satisfy the federal requirements under Section 2518 to be a qualified disclaimer. Section 2518 defines a qualified disclaimer as "an irrevocable and unqualified refusal by a person to accept an interest in property." Such refusal must be in writing and received by the transferor of the interest, legal representative, or the holder of the legal title to the property not later than nine months after the day on which the transfer creating the interest in such a person is made or the day on which such person attains age 21. The disclaimant must not have accepted the interest or any of its benefits, and the disclaimed interest is to pass without direction from the disclaimant.


Satisfying a state's disclaimer requirements does not necessarily mean that the federal requirements for a qualified disclaimer have also been met, which means that while the property may be successfully disclaimed under state law, the disclaimant may still have to pay applicable federal taxes on the transfer. See PLR 9714030 (Jan. 7, 1997).


Even though a disclaimer may be sufficient by state law standards, generally courts have held that the disclaimer must also comply with Section 2518 for federal tax purposes because of the distinct authority of state and federal law. In this context, state law generally governs ownership, while federal law controls taxation.United States v Mitchell, 403 US 190, 91 S Ct 1763, 29 L Ed 2d 406 (1971). InWalshire v United States, 2001 WL 34152074 (ND Iowa 2001), plaintiffs sought a refund of federal taxes levied on property properly disclaimed by state law but found by the IRS to not constitute a qualified disclaimer under Section 2518. In that case, the decedent executed and delivered a disclaimer of a remainder interest in property, but reserved for himself all "use and income from said property" for life. Id. The Walshire court agreed with the IRS's decision relying on the plain meaning of Section 2518's express rejection as a qualified disclaimer any disclaimer that results in disclaiming a remainder interest, but retaining a life estate.Id.


The timeliness requirement of Section 2518 presents an instance of when disclaimer may be sufficient under state but not federal law. For example, in Illinois a disclaimant can disclaim property at any time before acceptance of it. However, a qualified disclaimer requires that the disclaimer must occur no later than nine months after the interest is created in the disclaimant or the disclaimant turns 21. The U.S. Supreme Court found one exception to the timeliness requirement, holding that if an interest created in a transfer is made before January 1, 1977, disclaimer of that interest must be made within a reasonable time after knowledge of the existence of that transfer, because Section 2518 was enacted to be only prospectively applicable.Jewett v Commissioner, 455 US 305, 102 S Ct 1082, 71 L Ed 2d 170 (1982).


A disclaimant's failure to satisfy the "irrevocable and unqualified" provision in Section 2518 could also result in the IRS disqualifying the disclaimer for tax purposes. Illinois law is in line with Section 2518 insofar as both require that once the disclaimer is executed and delivered, it is irrevocable. Indiana and Wisconsin do not have statutory provisions regarding the revocability of disclaimers. When drafting a disclaimer in those states, be aware of Section 2518's additional requirement concerning revocability.


However, there is no corollary in Illinois, Indiana, or Wisconsin statutes for Section 2518's requirement that the disclaimer be "unqualified." The teeth of the "unqualified" requirement are bared only when the language of the disclaimer purports to make the disclaimer effective contingent on its status as a qualified disclaimer under Section 2518. Ironically, the IRS disqualifies disclaimers that are clearly written to be contingent on the disclaimer's status as a qualified disclaimer. Reportedly, this problem can sometimes be navigated to achieve the same effect as a disclaimer contingent on its status with the IRS by careful construction of the text of the disclaimer. For example, instead of writing the disclaimer to read, "If this is a qualified disclaimer under Section 2518, then I disclaim," it could read, "I disclaim a fractional share of this qualified plan, the numerator of which is an amount equal to the value of the plan that is exempt from federal estate tax, and the denominator of which is the value of the plan as finally determined for federal estate tax purposes." Eileen B. Trost and Charles A. Redd, Illinois Estate Administration, 2The Effective Use of Disclaimers in Estate Administration, § 18.6 (IICLE, 2003). Thus, in deciding on the language of the disclaimer it is important to choose appropriate wording to avoid problems from the IRS's "unqualified" requirement.

Conclusion


It is important to know and understand both the state and federal requirements for disclaimer to help clients avoid the potential pitfalls of using disclaimer as an estate- and tax-planning tool.

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