Qualified Disclaimers can be useful tools to alter the way property passes at death, and are often used as a method to reduce transfer taxes, such federal estate tax or gift tax.
Simply stated, a qualified disclaimer is a refusal to accept a gift, bequest, devise or beneficiary designation, done in a manner which meets certain statutory requirements.
Disclaimers may be made of lifetime gifts, but that is extremely rare, and this article will focus on transfers after a transferor’s death.
A qualified disclaimer after a transferor’s death must be in writing, it must clearly identify the property which is being disclaimed, and it must be signed by the person making the disclaimer, or his or her legal representative. The written disclaimer must be delivered to the transferor’s legal representative, such as the executor of an estate, and in North Carolina to the probate court, within nine months after the transferor’s death, with the exception of a disclaimer by a minor disclaimant, which may be made within nine months after the minor disclaimant’s twenty-first birthday.
Property cannot be disclaimed after it has first been accepted by an individual. For example, if an individual accepts stock dividends, he or she cannot later disclaim the shares of stock which paid those dividends.
The disclaimed property passes as though the disclaimant had predeceased the transferor. If there is a will, it passes to the successor devisees or beneficiaries under the will, after it has been disclaimed by the primary devisee or beneficiary. If there is no will, the property must pass to the secondary heirs under state law, who would have inherited the disclaimed property if the disclaimant had predeceased the decendent.
The person making the disclaimer cannot direct that a disclaimed devise or inheritance be passed to someone else, other than the person or persons who would have received the property if the disclaimant had predeceased the transferor. For example, a will leaves property to the transferor’s brother if he survives the transferor, and if he does not survive the transferor, the will leaves the property to the transferor’s sister. The disclaimant cannot disclaim the property and direct that is passes to his or her children, instead of to the sister.
The disclaimed property passes to the successors without any tax consequences to the person making the disclaimer, provided that the disclaimer is “qualified.” That is, the qualified disclaimer is not subject to gift tax, which would have been applicable if the person making the disclaimer had accepted the property and subsequently made a gift of that property to the transferees.
Generally, a disclaimant cannot disclaim property to a trust that names the disclaimant as a beneficiary of the trust or gives the disclaimant the power to direct the further disposition of the disclaimed property. For example, if the disclaimant is also the trustee of the trust to which the disclaimed property passes because of a disclaimer, and, as Trustee, has the discretionary power to direct its further disposition then the disclaimer would not be qualified unless the disclaimant also disclaimed his discretionary power.
There is an exception for a spouse, who can be a beneficiary of a trust, but the spouse cannot have the power to further direct the disposition of the trust property after the disclaimer, unless the spouse also disclaims his or her right to direct such disposition.
It is possible to disclaim partial interests in property, but not interests which cannot be severed into separate shares at the time of the disclaimer. For example, a person may disclaim 1,000 out of a total 2,000 shares of stock in an estate, but he or she cannot accept the dividends for life and disclaim the “remainder interest” in those shares after his or her death. In that case, a “vertical” disclaimer of half the shares will work, but a “horizontal” disclaimer would not work.
If the disclaimant is the trustee of the trust into which property is disclaimed, but as trustee is given the authority to make distributions among several beneficiaries, then the disclaimant must also disclaim his or her fiduciary power to direct the disposition among those beneficiaries.
Generally, a person cannot disclaim property in order to become qualified for Federal Title XIX assistance, such as Medicaid. The person must disclose all of his or her property to qualify or to remain qualified, including any property the person has disclaimed or wishes to disclaim.
Disclaimers are very technical in nature and you should not try to disclaim property without the assistance of a qualified attorney.
Charitable Remainder Trusts can be useful tools to avoid or to postpone capital gains tax on the sale of appreciated assets, for someone who wants to make a charitable gift after the termination of the trust. A person (the trust “grantor”) creates a trust which pays a stream of distributions each year to one or more beneficiaries (the “income beneficiary”) for life or for a term of years, after which the trust terminates and the remaining trust assets are distributed to a tax-exempt organization or organizations (the “remainder beneficiary”). Since the remainder beneficiary is a charitable organization, any capital gains which are retained in the trust are not subject to capital gains tax.
There are two types of charitable remainder trusts, called Charitable Remainder Annuity Trusts or CRATs and Charitable Remainder Unitrusts or CRUTs. A CRAT pays fixed distributions to the income beneficiary based on the original value of the trust assets, whereas a CRUT adjusts the distributions each year to reflect any increases or decreases in the value of the trust assets.
Example: $1,000,000 in assets are transferred to a charitable remainder annuity trust, or CRAT. The Grantor is to receive 5% of that value, or $50,000, per year, until the trust terminates. The income beneficiary frequently is a married couple and the trust term may be for their joint lifetimes and for the lifetime of the survivor. If the trust is funded with appreciated assets, no capital gains tax will be payable upon the sale of those assets. If the assets are worth $1,000,000 at the time of the gift and if they are sold for that amount, assuming that they were originally acquired for $100,000, the trust would not pay income tax on the $900,000 capital gain when the assets are sold. In addition to avoiding capital gains tax at that time, the grantor gets a charitable deduction on his or her income tax return for the value of the charitable remainder interest, calculated by Treasury actuarial tables applicable when the contribution to the trust is made. When the trust terminates – often after the death of the second spouse to die, the remaining trust assets are paid to a tax-exempt organization or organizations (the “charitable remainder beneficiary”) as set forth in the trust agreement.
A charitable remainder “unitrust” or CRUT is similar to an annuity trust, except that the distributions are adjusted annually, to reflect any increase or decrease in the value of the trust assets. If a 5% Unitrust was originally funded with $1,000,000 in assets, but grows in value to $1,100,000, the unitrust distributions for the following year would be 5% of the new value, or $55,000. This is different from a CRAT or annuity trust, for which the distributions would remain the same, even if the value of the trust assets increases or decreases.
Please note that the distributions from a CRT to the income beneficiary are taxable, to the extent that (a) the trust has taxable income, including capital gains, and/or (b) the trust had , in previous years, taxable income which has not been distributed to the income beneficiary. The trust cannot avoid income tax by investing in tax-free bonds until all taxable income has first been distributed, which makes this strategy impractical.
The general rule is that a CRAT or CRUT is required to distribute at least 5% annually, but there are exceptions for certain types of unitrusts. For example a “net income” CRUT (sometimes called a NICRUT) is not required to distribute more than its net income, and a “net income” CRUT with makeup provisions” (sometimes called a NIMCRUT) may make up income arrearages from past years (i.e., from years in which the trust was allowed to distribute less than the unitrust percentage), until the excess distributions have caught up with those arrearages. Thus a 5% NIMCRUT which earns only 1% in a given year would distribute only 1% currently and would accrue a 4% arrearage, which may be distributed only from excess income in subsequent years, i.e., income in excess of the 5% unitrust percentage. If 7% income is earned in a subsequent calendar year, the 2% overage for that year in excess of 5% may be distributed to the income beneficiary as a make-up distribution.
There are certain types of investments which enable the trustee to have some control over the realization of taxable income of a trust, in which case the trustee may minimize taxable income in one year and maximize taxable income in another year.
Occasionally someone creates a CRT which he or she later desires to exit. Circumstances can change over time, and sometimes there is an unanticipated major life event, which causes a change of mind. The trust itself is irrevocable, but there are alternatives which permit an income beneficiary of a CRT to obtain a more suitable result.
Let us suppose that the spouse of the trust grantor unexpectedly dies and later the grantor remarries and wants to make the new spouse an income beneficiary. Since the original trust was irrevocable, it cannot be changed to substitute the new spouse as a replacement beneficiary. In that case the grantor may want to exit the original trust in a manner permitted by law and to enter into a new trust agreement under which the new spouse is an income beneficiary.
There are several alternative methods for exiting an existing charitable remainder trust:
Temination of a CRT. One option is for the trustee simply to terminate the trust, in which case the trust assets must be divided between the charitable beneficiary and the income beneficiary strictly according to Treasury actuarial tables, following procedures established by the IRS. Care must be taken to avoid “self-dealing” under Code Section 4941, which could subject the trust to severe penalties.
Sale of income interest. Another option would be for the income beneficiary to sell the income interestin the trust to a third-party buyer. An important benefit from this alternative is that it frequently results in getting more money to the income beneficiary than would be received in a straightforward trust termination. Please note that the income interest in a CRT is considered a capital asset for income tax purposes, and if the sale of that capital asset results in a higher price than the actuarial value of that asset under the Treasury actuarial tables, there would be a taxable capital gain for the income beneficiary.
The original CRT would continue to exist under this alternative, under the same terms and conditions, but with a different income beneficiary – but please be aware that if the original term of the trust was measured by the life of the original income beneficiary, there would be no change in the term of the trust and the original income beneficiary’s life would continue to be the measure for the remaining term of the trust.
The proceeds received by the income beneficiary from the sale of the income interest could be contributed to a new charitable remainder trust if the Grantor so desired, with income tax benefits applicable to a new CRT, but the new trust would be scaled down in size as compared to the original trust unless additional assets were added to the new trust. The new trust could have different beneficiaries than the original trust, such as a spouse by a second marriage or other family members.
CRT Rollover. A third option could be a charitable remainder trust “rollover,” where the income beneficiary rolls over his or her income interest to a new CRT. Initially, the new CRT would have no assets other than the right to receive unitrust distributions from the old trust, which would continue to exist. However, an important benefit of this alternative is that the income interest from the old trust can be sold by the new CRT to a third-party buyer, and if the sale price is higher than its actuarial value under the Treasury tables, there will be no capital gains tax on the sale of that income interest, as long as the gain is retained by the trust. The proceeds of sale could be invested by the new CRT differently than the assets of the old trust, which investment strategy may be more appropriate for the new trust. The income beneficiary from the old trust would be the grantor of the new CRT and would get income tax benefits applicable upon the creation of a new CRT. New beneficiaries could be named for the new trust.
The original CRT would continue to exist and the charitable beneficiary would still receive the remainder distribution on termination of the trust under the original terms of the trust. Please note that if remaining term of the old trust was based on the measuring life of the original income beneficiary, that same person’s life would continue to be the measuring term for the old trust, even if that person is no longer receiving the unitrust distributions from the old CRT.
Distribution to charitable beneficiary. Lastly, an income beneficiary who no longer needs or wants the income distributions from the CRT may want to terminate his or her trust by giving the income interest to a charitable remainder beneficiary. If that is done, then the charitable remainder beneficiary would own both the income interest and the remainder interest, and the trust could be terminated. A beneficiary who gives his or her income interest to a charitable organization will get a charitable deduction for giving that income interest to charity, based on the value of the income interest under the Treasury actuarial tables at the time the trust is terminated.
Charitable remainder trusts often last for one or more decades. Although the original reasons for creating the trust were presumably valid at the time the trust was created, circumstances can change over time. Whatever the reason for the exiting a CRT, the procedure is complicated and in some states may even require court action. You need to consult with an experienced professional to discuss your situation and to determine the best option available for you.
Prior to the adoption of The SECURE Act of 2019, the required minimum required distributions (RMDs) for retirement accounts were based strictly on the actuarial life expectancy of the beneficiary. If the beneficiary of the retirement account was a trust, the distributions from the retirement account to the trust were based on the age of the trust’s “identifiable primary beneficiary.” If there were several identifiable beneficiaries, the RMD was based on the life expectancy of the oldest identifiable beneficiary.
The SECURE Act of 2019 changed the required minimum distributions (RMD) for retirement account beneficiaries (including identifiable beneficiaries of trusts) other than spouses, including adult children or grandchildren. The RMD has been changed from their actuarial life expectancy to 10 years (maximum), subject to exceptions. An exception is still available for beneficiaries who are “disabled” as defined by Internal Revenue Code Section 72(m)(7) or “chronically-ill” as described by Code Section 7702B(c)(2), with limited exceptions. The RMD for trusts on behalf of those beneficiaries is still based on the actuarial life expectancy of the identifiable primary beneficiary, and is not subject to the 10-year maximum payout applicable to most beneficiaries.
The Secure Act of 2019 virtually eliminated the “Stretch IRA” strategy to reduce IRA distributions by naming very young beneficiaries, but some of those benefits still exist for disabled or chronically-ill beneficiaries.
Distributions from a retirement account result in taxable income to the beneficiary or beneficiaries who receive the distributions. When a distribution is payable to a trust, the trust receives the taxable income, but the income tax liability for the distribution is passed on to the beneficiaries to whom the trust further distributes the income. Trusts are taxable entities and they file fiduciary income tax returns each year and pay income tax on any undistributed income. However, if distributions to beneficiaries are made during the year (or early in the following year, if the trust so elects on its timely-filed fiduciary income tax return), the trust can claim a “distribution deduction” on its fiduciary income tax return. That is, the trust can deduct from its taxable income the amount distributed to trust beneficiaries, and the trust issues a Schedule K-1 to the trust beneficiaries, reporting the distribution as taxable income to them. The tax laws discourage trust income from being accumulated in a trust by taxing undistributed trust income at much higher rates than the rates applicable to individuals.
The terms of some trusts require that the trusts distribute all their income to trust beneficiaries each year. These trusts are often called “simple trusts,” but insofar as retirement benefits are concerned, this type of trust can be categorized as a “Conduit Trust.”
A Conduit Trust is sometimes called a “see-through” trust, since the retirement distributions are taxable to the trust beneficiaries who end up receiving the distributions, and are not taxable to the trust.
Most of the time, overall income taxes are` reduced if a trust distributes retirement account income to the beneficiaries of a trust – because of the high tax rates applicable to trusts. However, minimizing taxes may not be the only consideration.
If the beneficiary of the IRA is a trust for a special needs beneficiary who is an “identifiable primary beneficiary,” any distributions of retirement account income from the trust to the trust beneficiary might result in too much income for the beneficiary, thereby disqualifying the beneficiary from means-tested governmental benefits, such as Medicaid.
An Accumulation Trust is an alternative to a Conduit Trust. The Accumulation Trust can be named as a beneficiary of retirement account benefits for an identifiable primary beneficiary, instead of a Conduit Trust. If the retirement income is not required to be distributed to the identifiable primary beneficiary and it may instead be retained by the trust, then the retirement account income would not cause the beneficiary to lose means-tested benefits, such as Medicaid. See Reg. Section 1.401(a)(9)-5, Q & A-7(c)(3), Example 1.
Consequently, an Accumulation Trust may be appropriate where the identifiable primary beneficiary of a trust is a special needs individual. The Accumulation Trust allows the trustee to receive the RMD from the retirement account, but does not require the trustee to distribute the RMD to the special needs beneficiary each year, thereby preserving the eligibility of the special needs beneficiary for needs-based government benefits. Instead of distributing the benefits to the beneficiary every year, which is a requirement of a Conduit Trust, the trustee of an Accumulation Trust can retain retirement benefits within the trust for future distributions to the special needs beneficiary or to the remainder beneficiaries of the special needs trust.
An Accumulation Trust which accumulates retirement distributions within the trust and does not distribute those benefits to the beneficiary must pay income tax on the accumulated income at trust tax rates, which are much higher than individual rates. However, even highly-taxed retirement account income which is accumulated within a special needs trust might be preferable to having the trust beneficiary declared ineligible for means-tested benefits, such as Medicare.
That is, if a Special Needs Trust is required to distribute to beneficiaries the required minimum distribution (RMD) from retirement accounts, the distributions would reduce the trust’s taxable income on the trust’s fiduciary income tax return, but would increase the beneficiary’s income. If the trust is an Accumulation Trust and is not required to distribute the income to the special needs beneficiary, the undistributed income is taxable to the trust itself, and it is not deemed to be taxable income of the trust beneficiary; since the income is retained by the trust, it is not considered to be the beneficiary’s income and does not disqualify the beneficiary from means-tested government benefits.
To be a valid Accumulation Trust, (a) the trust must be a valid trust under state law, (b) the trust must be irrevocable, (c) the beneficiaries must be identifiable and (d) certain documentation must be provided to the plan administrator.
As a result, even though the RMD may be taxable to the Accumulation Trust in high income tax brackets, The SECURE Act of 2019 may permit smaller RMDs from a retirement account to a trust for a disabled or chronically-ill beneficiary, in which case the amount required to be distributed to the trust will often be a smaller amount than would be applicable if the beneficiary were not disabled or chronically ill. That is, the tax detriment caused by the high fiduciary income tax rates, may be partially offset by a lower RMD from the retirement account to the trust.
If you currently have named a trust for the benefit of a disabled or chronically-ill trust beneficiary as beneficiary of your retirement account, you should review the terms of the trust with a qualified attorney, to make sure that the trust is not a Conduit Trust, which could render the trust beneficiary ineligible for means-tested government benefits, such as Medicaid.
If you have a retirement account or accounts from which you want to accumulate retirement income in trust for the possible needs of a disabled or chronically-ill beneficiary, you should consider having the retirement account payable to an Accumulation Trust for that beneficiary, instead of a Conduit Trust, which must be paid out at least annually to the beneficiary.