Significant recent developments in estate planning.

• Author: Nager, Ross W.
• Position: Part 1

Cases and Rulings on Disclaimers, Debts, Claims and Administration Expenses, Gifts, Life Insurance, Marital Deduction, Powers of Appointment and Retained Interests

Once again, we have prepared our annual review of significant recent court decisions and IRS rulings. The results, contained in this issue and in the January 1994 issue, concern estate planning developments during the period Apr. 1, 1992 through Mar. 31, 1993. The summaries of developments will be supplemented by editorial comments (i.e., "Critiques" or "Planning hints") as they occur to us.

As a general note of caution, the estate planner should determine the current status of a reported development, particularly if the IRS has appealed or otherwise indicated that it will not follow a court decision. In such cases, the estate planner should emphasize to clients that the recommended plan, although supported by a court decision, may lead to litigation in which the IRS may prevail.

Part I, below, will discuss the following topics: disclaimers, debts, claims and administration expenses, gifts, life insurance, marital deduction, powers of appointment and retained interests.

In general, no developments occurring after Mar. 31, 1993 are included within this review, except when a court case or ruling has been issued affecting a development included in the text of this article.

Disclaimers

Recent developments involving disclaimers included the following.

* Nine-month disclaimer period begins with date of death, not date will is probated.

* Dividend deposited unknowingly in disclaimant's account does not constitute acceptance.

* Qualified disclaimer by children and grandchildren of their residual interests increased the marital share.

* Nine-month disclaimer period begins

with date of death

In Fleming,(1) the decedent's husband died during September 1983 and bequeathed his residuary estate to his wife. In January 1984, his will was admitted to probate. The decedent died in May 1984. In August 1984, the decedent's executor filed a petition to disclaim her estate's interest in the husband's assets. The Seventh Circuit held that the disclaimer was not timely under Sec. 2518.

Critique: In general, Sec. 2518 requires that a disclaimer be filed in writing within nine months of the day on which the transfer creating the interest is made. The taxpayer argued that, under Illinois law, an interest in a decedent's property is not created until the will is submitted for probate. As such, the disclaimer was timely, since it was filed within nine months of that date.

The Seventh Circuit disagreed. It noted that the Illinois statute did not clearly and unambiguously state that a testator's assets are transferred only after a will is submitted to probate. Notwithstanding local law, however, the court noted that the underlying purpose for enacting Sec. 2518 was to establish a uniform standard "for determining the time within which a disclaimer must be made."(2) Looking to varying state law to determine when a transfer is made would defeat the congressional goal of uniformity. Further, Regs. Sec. 25.2518-2(c)(3) indicates that the date of death should be treated as the beginning of the disclaimer period within the meaning of the statute.

Planning hints: The taxpayer in Fleming pursued a lost cause from the outset. Both the regulations and the applicable committee reports clearly indicate that the date of death is the beginning of the disclaimer period. Further, Congress's clear intent was to remove local law considerations when determining a disclaimer's gift tax implications.

Unfortunately, the facts in Fleming placed a burden of urgency on the executor. The decedent died eight months after her husband. Further, it is unlikely that a disclaimer would have been made had she lived. Thus, the executor had only a month to get his planning house in order. However, the pressures imposed by the decedent's death eight months into the disclaimer period did not absolve the executor from taking the requisite action within the statutory period.

* Dividend deposited unknowingly in

disclaimant's account is not acceptance

In IRS Letter Ruling 9243024,(3) the decedent died holding 449.25 shares of an S corporation, which passed to the taxpayer by intestacy. A few months after the date of death, these shares paid a dividend to the estate. The decedent's administrator deposited it into a joint account of which the taxpayer was the surviving tenant. The taxpayer was at all times unaware of this dividend.

Within the period specified in Sec. 2518, the taxpayer sought to disclaim 55.65% of the shares (i.e., 250). The IRS found that the planned disclaimer conformed to the statutory requirements.

Critique: One of the criteria detailed in Sec. 2518 for a qualified disclaimer is that the disclaimant not accept any benefits from the property. Regs. Sec. 25.2518-2(d)(1) states that a prohibited acceptance of benefits includes accepting interest, dividends or rents or directing others to act with respect to the property. In Letter Ruling 9243024, the taxpayer was unaware of the dividend paid into her joint account and had not appropriated funds from that account. Further, she was neither a director of the corporation nor had she attended any shareholder meetings.

The IRS also stated that the disclaimer was not barred simply by the fact that bare title to the shares passed to her under the local intestacy law. Acceptance presupposes the receipt of more substantive benefits than temporary possession of legal ownership. Finally, the disclaimer of 250 shares was considered a valid "fractional disclaimer" within the meaning of Sec. 2518.

Planning hints: A disclaimer can be one of the most useful tools in postmortem planning. The Sec. 2518 rules are not onerous, but they must be complied with precisely. An untimely election and the inadvertent acceptance of benefits are the two most common reasons that disclaimers fail. Estate advisers should act carefully to maintain the option to use the disclaimer provisions. Depositing the dividend check to the taxpayer's account would have been fatal had she known of the transaction and not taken immediate steps to reverse it.

* Disclaimer by children and grandchildren

Increased marital share

In IRS Letter Ruling 9310020,(4) the decedent, a California resident, provided a "widow's election" bequest in his will. If the spouse so elected, the decedent's separate property, together with both his and his spouse's interests in community property, would be transferred to a marital deduction trust in which the surviving spouse had a right to income for life. Absent consent, the spouse would receive only her one-half community property interest under California law. The decedent's separate property and his share of community property would pass in trust for the benefit of his children, with the remainder passing outright to his grandchildren.

The surviving spouse executed the requisite consent. However, shortly thereafter, she revoked this document. Her children and grandchildren then proposed to disclaim their residual interests except to the extent of certain private company shares equal to a stated value. The IRS ruled that the disclaimers would be "qualified" under Sec. 2518 and that any amounts passing to the spouse by intestacy would qualify for the marital deduction.

Critique: The widow presumably made the election to qualify the entire estate for the marital deduction and maximize the total assets available for her support. Working in conjunction with her descendants, the consent's revocation dramatically changed the estate plan and tax consequences. The revocation redirected the decedent's estate to the descendants' trusts. At first blush, that action substantially increased the estate tax liability and eliminated all but the widow's community interest from the property available for her support.

The disclaimers shifted a substantial portion of the property back to her. Their effectiveness rested on the children's ability to remove all but the stock from the various trusts. Generally, a disclaimer will not qualify if a beneficiary merely disclaims income from specific property held in trust, while continuing to receive income from the remaining properties held in the same trust. Since the grandchildren received trust residue outright on the children's deaths, the disclaimers removed the property from the trusts. Consequently, the children did not retain a continuing interest. In light of the above, the IRS ruled that the disclaimers were timely under the statute and met the requirements of a fractional-interest disclaimer, as the shares retained from the residuary estate were severable property within the meaning of Regs. Sec. 25.2518-3(a)(1)(iii).

Similarly, in IRS Letter Ruling 9228004,(5) a series of disclaimers was executed by the decedent's children and grandchildren to secure a marital deduction. in that ruling, the testator's share of community property was bequeathed to a trust that did not qualify for the marital deduction. Once again, the result was dependent on the cooperation of willing and acquiescent second and third generation family members.

Planning hints: The effect of the disclaimers in Letter Ruling 9310020 was substantial. First, they greatly increased the amount of assets that the surviving spouse would otherwise have received by taking against the will. Second, they dramatically changed the nature of her interest in these assets. Under the will, she would have received merely a life estate in all of the decedent's property, while under the present arrangement she obtained an outright interest in a significant portion of these assets. Third, the estate was relieved of a substantial transfer tax cost. Fourth, when the children and grandchildren disclaimed, they retained closely held stock. Presumably that retention would avoid later inclusion in the widow's estate of that stock's substantial appreciation potential.

Finally, all this...