Life insurance on the young adult

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What is a disclaimer?

As the last item shows, courts sometimes have to deal with disclaimer issues. A disclaimer is a process by which someone who inherits property can essentially say “no, thank you” and decline to accept it. This can be done with property passing by a will, a trust, or other non-probate procedures such as joint tenancy or beneficiary designations.

If property is disclaimed, it then passes to the person who would have received it if the disclaiming recipient had not been named. A very important point is that the disclaiming recipient cannot specify who is to receive the property. If B wants to have property pass to C instead of to himself, he must accept the property and then make a gift to C. This may well use up some of his lifetime gift tax exemption. 

Disclaimers can apply to only a part of a gift. If a will calls for B to receive $100,000, he can accept $50,000 (or any other figure) and disclaim the rest.

Disclaimers are governed by both state and Federal law. The Internal Revenue Code provides rules that govern “qualified disclaimers” for Federal estate tax purposes. Both the Federal and the state statutes provide that a person cannot disclaim property if he has accepted it, gained any benefit from it, or if he has accepted any consideration from another person in exchange for the disclaimer. 

Disclaimers can be useful tools in succession planning. An example: a client who has a retirement account may designate his wife as the primary beneficiary and his brother as the secondary beneficiary, with the plan that 

• his wife will take over the account if she needs the money, but 
• she will disclaim it if she doesn’t (if other accounts and property she receives are sufficient to meet her needs), and thus allow the account to pass to the brother instead.

In re Milmet Estate

Morris Milmet was the owner of an investment firm, M&S Investment, Inc. After he died, his estate apparently exceeded the then-applicable exclusion amount by a significant margin, and the estate would have been unable to pay the assessed estate tax without liquidating the company he had built. It appears that most of his estate consisted of shares in the company. (We are reading between the lines a bit, since the opinion does not provide much in the way of factual background.)

His will had called for the creation of a testamentary trust, dividing his assets between his wife (the marital share) and his other beneficiaries (the residuary share). Somehow, the customary provisions were not used or were not effective. Most estate plans are carefully worded to ensure that only an amount matching the applicable exemption amount passes to persons other than the spouse. This one apparently didn't. Enough passed under the residuary share that a significant estate tax liability would have been incurred. So the beneficiaries acted to avoid that result, avoid the estate tax, and allow the company to stay in business. The residuary beneficiaries executed apparently timely disclaimers of their interests, at least to the extent of the excess, allowing those assets to pass to the decedent's wife, and thus escape taxation under the marital deduction.

In exchange, the complaint alleged, the wife agreed that she would later "provide the Residuary Beneficiaries with the value of their interest in the Residuary Estate at a later date." How and when she would do so was not stated in the opinion.

The other beneficiaries later sued her for breach of contract, fraud, conversion, etc. for apparently failing to follow through. The complaint alleged that she "retained the 40% of the residuary estate" rather than passing it back to them.

The probate court dismissed the complaint for failure to state a claim. (Under that rule, the court considered only the allegations made in the complaint, and did not refer to any facts or documents.) The court reasoned that a disclaimer under section 2901 of the Estates and Protected Individuals Code is, by its very nature, a release of any interest in the subject property. The disclaimer would be inconsistent with the retention of any interest sufficient to support a breach of contract claim.

The Court of Appeals reversed. It found that enough had been alleged to raise a factual issue. In particular, it held, the probate court needed to determine whether the agreement had been made, and what the terms were. It went on to note, however, that if the facts as alleged were to be established, this would make the purported disclaimers void ab initio (from the outset). This would mean that they would be regarded as not taking effect, and the estate and its beneficiaries would be returned to the position they had been before this agreement was put into effect.

The court noted in a footnote that the purported disclaimer was likely ineffective for its intended purpose of avoiding estate taxes on the property. Quoting from Estate of Monroe v CIR, 124 F3d 699, 705 (5th Cir 1997), it noted that "the acceptance of any consideration in return for making the disclaimer is an acceptance of the benefits of the entire interest disclaimed." It also noted that section 2910 of EPIC provides, for state law purposes, that "The right to disclaim is barred to the extent provided by other applicable law."

Judge Murphy, concurring in part and dissenting in part, noted that the disclaimer agreements had expressly recited (to comply with IRS requirements) that "the petitioners had not received and would not receive any consideration for disclaiming their interests."

Ultimately, he concluded, whichever theory was eventually pursued by the parties and accepted by the court, the agreement was illegal and/or contrary to public policy.

What will happen next? The case was remanded back to the probate court. It appears inevitable that the estate will be reopened, the disclaimers invalidated, and the residuary property will pass to the intended beneficiaries under the will. An amended Form 706 will have to be filed, and the appropriate estate taxes paid. Late filing penalties and interest will undoubtedly be assessed. There would be a very significant chance of criminal charges being filed, at least for the filing of a fraudulent original Form 706. None of those prospective penalties was specifically mentioned in the opinions, but they were surely in mind as the Court of Appeals opinions were written.

The decision