Maximizing the Applicable Exclusion Limit

One common estate planning strategy for married couples is for each spouse to leave his or her entire estate to the surviving spouse; the unlimited marital deduction allows the spouse to avoid federal estate taxes in this situation.

However, this does not account for the applicable exclusion limit, which in 2006 allows each individual to transfer only $2,000,000 to heirs free of gift or estate taxes. This potentially subjects the survivor's estate to higher than necessary future taxes, since all property remaining in the estate is subject to estate taxes.

One popular trust arrangement designed to address this issue is the common "A/B" combination, typically set up as a revocable trust that can be modified at any time before death. However, a qualified disclaimer can also provide some flexibility after a spouse has died.

Qualified Disclaimer

This technique can be useful when a spouse dies without "A/B" trusts or similar arrangements in place. In order to avoid wasting the first spouse's applicable exclusion amount, the surviving spouse can disclaim a portion of the inherited property, which then passes to other heirs or beneficiaries as if the surviving spouse had predeceased. The estate can then take advantage of the applicable exclusion amount with respect to the disclaimed property.

In order to disclaim property in this way, the following requirements must be met:

  • A disclaimer must be prepared in writing, and it must be irrevocable.
  • The disclaimed interest must pass without direction by the person disclaiming the property. Therefore, before you decide to disclaim, you should know who would receive the property under the will or applicable state laws.
  • The written disclaimer must be received by the grantor of the interest (or the grantor's estate) within nine months of the taxable transfer creating the interest (or, where the disclaimant is a minor, within nine months of the disclaimant's 21st birthday).
  • With the exception of a spouse, the person disclaiming the property cannot receive any benefit from the disclaimed property, such as trust income. (If a surviving spouse needs to receive income from the disclaimed property, the decedent's will could provide for this by establishing a disclaimer trust. The surviving spouse can then establish an "A/B" trust after the death of the first spouse.)

Disclaiming an inheritance can have considerable tax benefits in certain situations, but it is not always a desirable choice: for instance, if the estate is small and the surviving spouse's standard of living depends upon all the assets, he or she should not disclaim the inheritance. In addition, if property of substantial value is transferred to an individual two or more generations younger than the donor, a disclaimer could trigger generation-skipping transfer taxes.

Before making any decision to disclaim an inheritance, you should consult a legal professional for specific advice about your situation.

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