A disclaimer is a refusal by someone to accept property that was left to them through a trust or estate. The person signing the disclaimer makes an irrevocable and unqualified decision to refuse any interest in the disclaimed property.

Disclaimers are incredibly useful for straightening out tax planning and drafting problems with an estate plan.  The disclaimer allows a “second look,” giving attorneys the ability to rewrite portion f of the estate plan to reach tax or practical goals or to fix problems with the estate.  Common examples include:

• Avoiding generation-skipping transfer tax problems;
• Asset protection by preventing disclaimed property from becoming subject to a beneficiary’s creditors;
• Remedying the failure to make full use of the decedent’s annual exclusion amount;
• Adjusting between the credit shelter and marital deduction bequests in a decedent’s estate; and
• Preventing acceptance of problem assets, such as environmentally-contaminated real estate.

Qualified Disclaimers

All disclaimers should be “qualified disclaimers,” a term of art referring to disclaimers meeting the requirements of Section 2518(a) of the Internal Revenue Code.  If the disclaimer is a qualified disclaimer, it is treated as though it had never been transferred for tax purposes.  In order to qualify, the disclaimer must meet the following requirements:

• It must be irrevocable.  The disclaimant can’t leave open the possibility of changing his or her mind.
• It must be unqualified.  The disclaimant can’t make the disclaimer contingent on anything or redirect the distribution of the asset.
• It must be in writing.
• It must be delivered to the transferor of the interest, or his or her legal representative, or the holder of legal title to the property within 9 months of the later of:
  • The date upon which the transfer creating the interest is made or
  • The date upon which the disclaimant turns 21.
• The disclaimant must not have accepted any interest in the disclaimed property or any of it’s benefits.
• The disclaimed interest must pass to the surviving spouse of the decedent or some other person without any direction by the disclaimant.

Partial Disclaimers

The Internal Revenue Code allows partial disclaimers.  As long as the requirements of Section 2518(b) are satisfied, the transfer of an undivided portion of an interest in property is treated as a qualified disclaimer of that interest.

A premarital agreement can be a tough topic to discuss and a tricky document to draft.  The discussion part is primarily the concern of the client.  Although the attorney can make suggestions about why premarital agreements might be a good idea in a given situation, it’s up to the clients to discuss this sensitive matter with each other.  But the drafting falls squarely on the attorney.

The drafting difficulty is a result of the interdisciplinary nature of premarital agreements.  At a minimum, the attorney needs to be familiar with estate planning, probate (including elective shares and other spousal rights), and matrimonial/family law.  Other laws affecting marital property can also come into play.

Take, for example, retirement plans.  If one spouse makes contributions to a retirement plan during marriage, should the premarital agreement require that he or she make equal contributions to the other spouse’s retirement plan?  That may seem like a good idea – unless you know that the husband’s retirement plan is a 401k and the wife’s retirement plan is an IRA, and that the contribution limits for these two types of plans are the same.  To make this judgment call, you would need at least some familiarity with the rules governing retirement plans.

In situations like this, where other areas of law or even non-legal rules could be involved, it is best to take a collaborative approach.  In the above example, working with the client’s financial advisor could help you spot the retirement planning issues that you might otherwise miss.  It’s best to hit the problem from as many different angles as possible.  This shared expertise will help ensure that the premarital plan will work as intended.

How would you like to set up a pot trust for your kids?

Actually, it isn’t as bad as it sounds.  A pot trust has nothing to do with illegal herbal recreation.

Pot trusts are designed to equitably distribute assets to a group of children with a range of ages.  For example, assume that a husband and wife want to distribute their assets to their children at the death of the second spouse.  Assume that their youngest child is 11 and their oldest is just finishing college.  Would it be fair to split the assets between these two children?

The answer in most cases is “no.”  The 25-year-old child has already been supported for the bulk of his youth.  He can spend his share of the trust on whatever he chooses.  The younger child, though, still has some years of dependency.  Her share will be spent on providing for her needs over the next decade or so.  The goal of dividing the estate between the children, which seemed fair enough at first, turns out to favor older children to the detriment of younger children.

Pot trusts are used to address this problem by delaying the division of assets.  Instead of dividing the assets equally upon the death of the second spouse, a pot trust could be used as a receptacle (“pot”) to hold the property until the youngest child graduates from college.  Until then, the money is held in the pot.  It can be spent on either child, but the primary purpose of the trust is to provide for the younger child until he reaches the age of self-sufficiency.

Once the younger child graduates from college (or reaches whatever trigger is described in the trust), the division of assets is finally made. At that point, the trust assets can be distributed to both of the children.  Each will have had their room, board, and college paid for, and each will receive an equal share of whatever is left after payment of those expenses.  This is a much fairer result in many situations.

In most situations, planning for the traditional nuclear family is straightforward.  When a husband and wife with children come in for estate planning, chances are that their wishes will be the same.  Each of them will want to leave their estate to the survivor after the first death, with the assets to be left to the children after the second death (the so-called “sweetheart” disposition).

But second marriages are more difficult, especially when there are children from prior marriages.  The spouses will often (but not always) want to make provision for the surviving spouse.  But at the end of the day, they want to be sure that the assets end up with their children (and not the surviving spouse’s children).

In this situation, the client’s concern is usually that leaving everything outright to the surviving spouse could effectively disinherit their children.  Husband wants to take care of Wife, but knows that if he leaves everything to her, she might leave it all to her children (and not his) at her death.  Wife has the same concerns.  Here are a few ways to address this situation.

Set Up a Trust

The preferred strategy in this situation is a trust.  The trust could be established at death through a Last Will and Testament (a testamentary trust) or during the creator’s lifetime (an inter vivos or living trust).

The use of a trust allows each spouse to control how the assets will be handled after their death.  Instead of leaving the property to the spouse outright, the spouse only has the use of the property during his or her lifetime.  At death, any unused property is distributed to the children of the predeceased spouse.

If both plans are set up this way, the predeceased spouse’s children will end up with the predeceased spouse’s assets at the death of the surviving spouse.  At the same time the surviving spouse’s children will end up with the surviving spouse’s assets.  This usually mirrors the intent of the parties.

Of course, there is still the possibility of wrongdoing.  The surviving spouse could hoard all of his or her own assets and drain the predeceased spouse’s trust.  This would effectively shift assets away from the predeceased spouse’s children to the surviving spouse’s children.

Opportunities for wrongdoing can be minimized by careful drafting.  A well-drafted trust could provide, for example, that the surviving spouse is to use his or her own resources before dipping into the trust assets.  An independent third-party trustee could be appointed to oversee distributions.  Precautions like this can help assure the clients that their wishes will be honored.

Note:  Some probate avoidance techniques, such as co-ownership and beneficiary designations can be particularly dangerous in a second-marriage situation.  When spouses hold property jointly with rights of survivorship or are named beneficiaries on each other’s accounts, the property involved will pass automatically to the surviving spouse at death.  The surviving spouse can then freely disinherit the predeceased spouse’s children, and there isn’t anything they can do about it.

Contractual Solutions

Agreements can also help second-marriage estate plans. The most common is a contract to make a will.  In this arrangement, the spouses would agree with each other to make both sets of children the beneficiaries of both estates.  No matter who dies first, the children of both spouses will share equally in the estate at the death of the second spouse.

Written agreements are a somewhat clumsy solution when compared to a trust.  There are too many possibilities for asset shifting during the surviving spouse’s lifetime. For example, the surviving spouse could shift assets to his or her children while still alive, reducing the amount to distribute at death.  Because there is no opportunity for a third-party trustee or fiduciary accountability standards, malfeasance of this nature can be difficult to police.

Every trust or estate arrangement involves a relationship between a fiduciary (the personal representative of the estate or trustee of the trust) and the beneficiary (the person or organization that is entitled to the assets).  There can be multiple fiduciaries and/or multiple beneficiaries, but the same relationship applies regardless of number.

The fiduciary holds legal ownership of the property.  This means that the fiduciary technically has the power to deal with the assets.  But the fiduciary doesn’t hold the property for his or her own benefit as such.  Instead, the fiduciary must handle the property in the best interest of the beneficiaries, who hold equitable title to the property.

It is not uncommon for disagreements to arise between the fiduciary and the beneficiaries, especially when a family member is named as fiduciary.  If there is already dysfunction in the family, the authority inherent in the role of fiduciary can go to the fiduciary’s head.  When the fiduciary starts abusing the power, disputes arise.

I had a case recently that involved just such a mess.  The oldest son resented the fact that his younger brother was chosen ahead of him as executor of his father’s estate. The younger son was almost giddy with the decision and didn’t miss a chance to rub it in.  When it came to making decisions regarding the property, the two brothers would always disagree, even when agreement would be in their mutual best interest.

Problems also arise when the trustee of a trust is also a beneficiary.  In this case, the trustee where’s two hats.  Say, for example, that the trust instrument gives the trustee the discretion to choose which assets will be distributed to which beneficiaries.  Assuming the trustee is also a beneficiary of the trust, can the trustee distribute cash to himself and hard-to-sell illiquid assets to the other beneficiaries?

The answer is “no.”  In situations like this, the attorney should be very clear that the role of personal representative or trustee is a fiduciary role.  The trustee cannot use that role to favor himself or herself as beneficiary of the trust.  He or she must fulfill trustee duties in as fair and impartial manner as possible.

But fiduciaries aren’t the only parties that get confused regarding their roles. The beneficiaries can also cause problems by taking it upon themselves to interfere with the day-to-day administration of the trust.  Absent some unusual provisions in the Will or trust instrument, this sort of interference is beyond the scope of the beneficiary’s role.  The trustee is responsible for the management of the trust.