Important considerations when receiving an inheritance - When should you reject a gift?

As discussed in Part I, there are several implications, tax and otherwise, that beneficiaries should consider when receiving an inheritance. In the vast majority of cases, beneficiaries are inclined to accept an inheritance; however, in some situations it makes sense for a beneficiary to reject it. When done properly to qualify for favorable tax treatment and other benefits, a gift is rejected using a “qualified disclaimer.” 

PART 2: DISCLAIMERS

What is a qualified disclaimer?

A “qualified disclaimer” is an irrevocable and absolute refusal to accept a gift. There are strict formalities required by the Internal Revenue Code for a qualified disclaimer, including all of the following:

1. the disclaimer must be irrevocable and unqualified; 
2. the disclaimer must be in writing; 
3. the disclaimer must be made within nine (9) months after the date of the gift (in the case of an inheritance this is typically 9 months after the date of death); 
4. the beneficiary must not accept the gift or any of its benefit prior to the disclaimer; and 
5. the rejected gift must pass without any direction on the part of the beneficiary and to someone other than the beneficiary (unless the beneficiary is the surviving spouse of deceased person).

Because these requirements must be strictly satisfied, a beneficiary considering rejecting a gift must plan carefully from the moment they become aware of the gift. (Sometimes, advance planning for a qualified disclaimer produces an even better result because the estate plan can specifically identify how a gift passes if and when a beneficiary executes a qualified disclaimer, allowing for ideal results). 

What happens when you make a qualified disclaimer?

When a beneficiary makes a qualified disclaimer they are called a “disclaimant.” The gifted property is deemed to have never passed to the beneficiary and instead passes directly to the successor beneficiary named under the deceased person’s estate plan (or in the absence of a plan, default inheritance laws of intestacy). Because the disclaimed gift is never received by the disclaimant, certain tax and creditor protection benefits may result. 

What are the benefits of making a qualified disclaimer?

1.    Generational planning

A qualified disclaimer is an effective vehicle for estate planning, particularly for a beneficiary whose personal wealth exceeds or is likely to exceed the applicable gift and estate tax exemption. This is because the disclaimant is treated as never receiving the gift, which is deemed to pass directly to alternate beneficiaries named in the estate plan or under default law (often the disclaimant’s children). As a result, the disclaimed gift passes directly from the deceased person to the alternate beneficiaries without the disclaimant making a taxable gift herself. The result is a disclaimant essentially choosing for a gift to go directly to her children without additional tax consequences.    

2.    Avoiding gift and estate tax  

A beneficiary who receives a gift that appreciates over his lifetime may ultimately owe estate tax on the appreciated value if he doesn’t consume (spend, rather than invest) the value. If the beneficiary doesn’t need the gift, the future appreciation is shifted to other beneficiaries who receive the gift instead. This may avoid gift or estate tax if the disclaimer results in gifts that effectively utilize an estate and/or generation-skipping transfer (GST) tax exemption, preserving more value for beneficiaries in the long term. For example, if a person dies and leaves assets to a surviving spouse who doesn’t need them, the surviving spouse and other beneficiaries may have the opportunity to make a qualified disclaimer to protect those assets so they can eventually pass to children or grandchildren free of additional tax. 

3.    Creditor protection 

Disclaimers may also be useful for individuals experiencing creditor problems. Under California law, disclaimers are binding and will usually deem the inherited asset untouchable by the disclaimant’s creditors. If a beneficiary with creditor problems makes a qualified disclaimer, this may preserve the gift for another family member instead of benefitting a creditor.   

How to decide to reject a gift

Beneficiaries may want to refuse to accept inherited assets for a variety of reasons. Done properly as a qualified disclaimer, potential tax and other benefits are available. Without a qualified disclaimer, a beneficiary who doesn’t need or want an inheritance is treated as having accepted the gift and then re-gifting it to another person. This “re-gift” may have gift, estate or GST tax consequences along with other drawbacks. 

Due to the significant benefits of a qualified disclaimer, and the drawbacks of not properly refusing a gift in the right circumstances, a beneficiary is well served by immediately consulting with tax or estate planning professionals when they learn they are expecting an inheritance. We are here to help beneficiaries understand whether rejecting a gift will benefit them or their families. 

This article is authored by Melody Mirbod.