Disclaimers or fixed formulas

The issue of using disclaimers or formulas to protect clients’ estates from taxes became much more complex with the advent of the rising estate tax exemption amount and falling tax rates.

Generally speaking, there is no need to establish a Credit Shelter or By-Pass Trust if the clients’ combined estate will fall below a single exemption amount. For that reason many attorneys are using disclaimers to build in flexibility to an estate.

How disclaimers work is relatively straightforward. Assets are divided into two separate shares during the lifetime of the married couple. At the first death, the written estate plan for that individual states that the deceased spouse’s separate assets are to be combined with the survivor’s assets.

The surviving spouse must decide to keep the assets (claim the inheritance) or refuse to accept the assets (disclaim the inheritance).

Asset disclaimed are set aside in a Bypass or Credit Shelter trust for the benefit of the surviving spouse. This amount and all of its growth is protected from estate tax.

The surviving spouse is left with the difficult decision: claim it or disclaim it. To answer that question, several interrelated issues need to be resolved:

What exemption will be applicable at the second death?

  • Will it be a higher exemption amount ($5,000,000) or a lower exemption amount ($1,000,000)?
  • What will be the size of the clients’ combined estate at death. Will the combined estate be less than one (or two) applicable exemption amount(s)?

The trouble with disclaimers is that they must be properly and timely implemented. Clients run the risk of tainting assets and thereby lose the ability to transfer assets into the tax protected trust.

Exposing the client to that risk may be acceptable when a large exemption amount can protect the combined estate. This risk may be unacceptable when the smaller exemption amount is available.

If the combined estate will be less than one exemption amount; then there is no reason to disclaim. If, however, the estate will be greater than one exemption amount, but less than two exemption amounts; then use of the disclaimer makes sense.

If the combined estate will be greater than two exemption amounts, then it may be appropriate to use fixed formulas (lead pecuniary or fractional share) rather than disclaimers to protect the estate from transfer taxes.

American Dream PlannerTM helps guide the attorney, accountant and financial planner in the quest for these answers. American Dream PlannerTM helps determine the ultimate size of the estate. Then, with point and click ease, the professional adviser can help determine whether or not the client needs the protections provided by a Credit Shelter or By-Pass Trust regardless of which tax code is imposed.