An “Innocent Little” Disclaimer Crushes Estate Plan

Back in 2001 when Mr. Schaffer executed his estate plan, language was added which allowed for a creation of a “pecuniary credit shelter trust” equal to the amount of the “aggregate federal estate tax exemption equivalent.”  Schaffer’s estate plan language went on to state that it provided that the credit shelter trust “shall not be reduced on account of any disclaimer by my wife.”  The final provision in Schaffer’s estate plan contained a conflicting provision which read, “if my wife disclaims any interest in any portion of the property otherwise passing outright to her under this Article of my will, such portion shall be added to the credit shelter trust.”  The purpose of the credit shelter trust created under Schaffer’s estate plan was to place a dollar amount equal to the amount that could pass free of estate tax into trust so that same dollar amount would eventually pass to his children without being subject to the estate taxes of his wife’s estate.  It makes sense and seems like sound reasoning, right?  Well, not so fast.

First, we must understand that the effect of a qualified disclaimer is to treat the disposition of the asset disclaimed as if the disclaimant had predeceased.  That causes the asset to be distributed to the contingent beneficiary under the terms of the provisions of the estate plan. Internal Revenue Code section 2518 provides that a qualified disclaimer must adhere to seven specific criteria, including that it must pass the disclaimed property without any direction on the part of the disclaimant.

Mr. Schaffer passed away in 2004.  At the time of Shaffer’s death, the dollar amount that could be passed free of estate tax was just over $700,000.  At that time, Mrs. Schaffer wasn’t relying on those funds to live (the funds which were transferred to the credit shelter trust under the provisions of her husband’s estate plan), so she disclaimed her interest in the credit shelter trust.  In plain and simple terms, this means that those specific assets passed immediately to the Schaffer children.

As you might imagine, Mrs. Schaffer ended up being taken to court by the IRS, who argued that Mrs. Schaffer disclaimed her interest in the $700,000 allocated to the credit shelter trust, therefore an estate tax was due because the value of assets disclaimed was in excess of the amount that could be passed free of estate tax.  The IRS maintained that the language of the estate plan was clear: the credit shelter trust was to be funded with the $700,000, and any amount disclaimed by Mrs. Schaffer was to be added to the credit shelter trust.  The IRS won the case, and the Schaffer family paid hundreds of thousands of dollars in estate taxes.

In this particular case, the attorney who prepared Mr. Schaffer’s estate plan could have simply allocated the designated securities to the credit shelter trust without an additional disclaimer by Mrs. Schaffer, and the estate tax imposed by the IRS could have been avoided.  This story is yet another cautionary tale of why it is imperative to retain the services of an attorney who specializes in estate planning and knows intimately the ins and outs of the law.