Qualified Disclaimer

What Is a Qualified Disclaimer?

A qualified disclaimer is a refusal to accept property that meets the provisions set forth in the Internal Revenue Code (IRC) Tax Reform Act of 1976, allowing for the property or interest in property to be treated as an entity that has never been received. Section 2518 of the IRC permits a beneficiary of an estate or trust to make a qualified disclaimer so that it is as though the beneficiary never received the property, for tax purposes.

Understanding the Qualified Disclaimer

Sometimes, the costs of receiving a gift may be greater than the benefits of the gift, as a result of tax implications. In these cases, refusing the gift may be the tax-efficient thing to do. The disclaim of any gift or bequest is known as a qualified disclaimer, for federal income tax purposes. The Internal Revenue Service (IRS) defines a qualified disclaimer as an irrevocable and unqualified refusal by a person to accept an interest in property.

Qualified disclaimers are used to avoid federal estate tax and gift tax, and to create legal inter-generational transfers which avoid taxation, provided they meet the following set of requirements:

1. The disclaimer is made in writing and signed by the disclaiming party. In addition, they must identify the property or interest in property that is being disclaimed. The disclaimed interest must then be delivered, in writing, to the person or entity charged with the obligation of transferring assets from the giver to the receiver(s).
2. The document is received by the transferor of the property (e.g., legal representatives or the holder of legal title to the property to which the interest relates) within nine months from the date the property was transferred. In the case of a disclaimant aged under 21, the disclaimer must be written less than nine months after the disclaimant reaches 21.
3. The disclaimant does not accept the interest or any of its benefits. In effect, once an individual has accepted the property, they cannot disclaim it.
4. As a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either to the spouse of the decedent, or to a person other than the person making the disclaimer.

Only if these four requirements are met can the disclaimant be treated as if they never received the gift in the first place. The disclaimed property is then passed to the "contingent beneficiary" by default, that is, to a party other than the original stated beneficiary of the gift or bequest. Basically, the property passes to the contingent beneficiary without any tax consequence to the person disclaiming the property, provided the disclaimer is qualified. Under federal tax law, if an individual makes a "qualified disclaimer" with respect to an interest in property, the disclaimed interest is treated as if the interest had never been transferred to that person, for gift, estate, and generational-skipping transfer (GST) tax purposes. Thus, a person that makes a qualified disclaimer will not incur transfer tax consequences because they are disregarded for transfer tax purposes. The federal law does not treat the disclaimant as if they had predeceased the decedent. This is contrary to many states' disclaimer laws in which disclaimed property interests are transferred as if the disclaimant had predeceased the donor or decedent.

Qualified Disclaimer Regulations and Estate Planning

Due to the strict regulations that determine whether disclaimers are considered "qualified" according to the standards of the IRC, it is essential that the renouncing party understand the risk involved in disclaiming property. In most cases, the tax consequences of receiving property fall far short of the value of the property itself. It is usually more beneficial to accept the property, pay the taxes on it, and then sell the property, instead of disclaiming interest in it.

If a disclaimer does not meet the four requirements listed above, then it is a non qualified disclaimer. In this case, the disclaimant, rather than the decedent, is treated as having transferred the interest in the property to the contingent beneficiary. Additionally, the disclaimant is treated as the transferor for gift tax purposes and will need to apply the gift tax rules to determine whether a taxable gift was made to the contingent beneficiary.

When used for succession planning, qualified disclaimers should be used in light of the wishes of the deceased, the beneficiary, and the contingent beneficiary.