The Financial Planner
The "Disclaimer." Just Say No?
Receiving an inheritance can be an emotional, exciting, and even life-changing event. But what if you don’t want to accept it? There are situations when accepting an inheritance may not be in your best interest, or not what you want for yourself. Our legal system provides us with a simple and straightforward way to say “no” to an inheritance: the disclaimer. We have the right to “disclaim” or turn down an inheritance (or a specific asset within an inheritance), as long as we follow the rules.
What is a Disclaimer?
The dictionary definition is a “formal refusal to accept an interest or estate.”1 In order for someone’s refusal to accept an interest to become a “qualified disclaimer” (meaning the IRS will not treat the asset as yours for tax purposes), it must meet the following requirements as paraphrased:
- The disclaimer is in writing (notarized) and delivered to the person controlling the estate (such as the executor or trustee) within nine months of the death or nine months after turning 21 if the inheritor is a minor.
- The person disclaiming has not accepted the interest or any of its benefits.
- The disclaimed interest passes without any direction by the person disclaiming, to either the decedent’s spouse or a person other than the person making the disclaimer.2
The writing must be very specific as to what you are disclaiming and follow all the rules (see 26 U.S. Code Section 2518). If you plan to disclaim but receive any part of the inherited interest, even briefly, it will be considered your asset.
How Does the Disclaimer Work?
When you disclaim an inheritance, you cannot stipulate where the asset or interest goes. The interest will pass on to the next heir according to the will, trust, beneficiary designation or intestate succession laws as though you did not exist.
For example, if a surviving parent’s will stated “everything will go to my two children in equal shares,” and Child 1 disclaims, then Child 1’s share will pass on to Child 2 as though Child 1 did not exist. If the will instead bequeathed the inheritance to “my two children in equal shares per stirpes,” Child 1’s disclaimer results in the inheritance passing on to Child 1’s children as though Child 1 was no longer alive. It is critically important to know where the asset will go before disclaiming. Once the disclaimer is made, you cannot revoke or rescind it.
Why Would You Disclaim?
- To keep from increasing the size of your estate. If you already have a taxable estate and you do not need the inheritance, it may be more tax efficient to let it pass to the next beneficiary, especially if that beneficiary is your own estate’s beneficiary (i.e. your children). If you received the (unneeded) inheritance, the estate taxes at your death would reduce its value and less would go to your heirs.
- To transfer wealth during life, gift tax free. If you disclaim an inheritance that ends up going to your estate beneficiaries, you are not making a taxable gift because the asset is not owned or controlled by you. You effectively transfer assets without using up any of your own lifetime estate and gift tax exemption amount. Inherited assets also receive a step-up in basis, whereas gifted assets do not.
- To prevent higher income taxes for you. If you inherit an income-producing asset that will put you into a higher tax bracket, and you don’t need the asset or the income, then disclaiming may be a way to benefit both you and next heir in line. This is especially true if the next-in-line is in a lower tax bracket and could use the income.3
- To prevent the inheritance of a “bad asset.” On occasion, an asset comes along that is a burden; something that costs more to own and/or liquidate than it is worth to you. It could be a timeshare, a piece of art, an unsellable property, or a property in an inconvenient location. In this situation it is best to consult with the resulting beneficiaries before disclaiming so they can consider how your disclaimer will impact them. They may also choose to disclaim.
- To correct unintended inheritances. Sometimes an inheritance may not be what the deceased person intended. Let’s assume that mom intended her three kids to inherit equally, and she stated this clearly in her will. Before she died, she gave one child a large amount of money to help him through a temporary situation, expecting to be paid back while she was alive. That child could disclaim an amount equal to two-thirds of the “loan/gift” he received to make all three inheritances equal, assuming the disclaimed amount would pass to the other siblings.
- To fund a family trust at the first spouse’s passing. Disclaimers are frequently used in estate planning as a way to provide flexibility for changes in circumstances and/or congressional changes to the lifetime estate tax exemption amount. The surviving spouse is given the right to disclaim certain assets which, when disclaimed, go into the family trust. This gives the survivor discretion over the amount going into the trust, and the ability to adjust to the family needs at the first death.
When Shouldn't You Disclaim?
There are a few situations where disclaiming does not work well. In Minnesota, disclaiming an inheritance is not allowed when the person disclaiming is insolvent;4 which means you cannot disclaim to get out of paying a debt. If you are trying to qualify for Medicaid, most states will consider a disclaimed inheritance as a recently transferred asset which could affect your eligibility for the program (see footnote 3). Likewise, if you are already on Medicaid and disclaim an inheritance, it will be deemed a disqualifying transfer and a penalty will apply.5
Disclaiming can be a useful financial planning tool in many situations. As with all tax, estate planning and estate settlement matters, it is best to consult with your estate planning attorney, your CPA and your financial advisor before taking any action so you can make fully informed decisions.
1. Retrieved from https://www.merriam-webster.com/dictionary/disclaimer
2. Retrieved from https://www.law.cornell.edu/cfr/text/26/25.2518-2
3. White, J. (2019, January 25). Thanks, but no thanks! How to refuse an inheritance by disclaiming. J.H. White Financial.
4. Minnesota Statutes 524.2-1106(b)(4) WHEN DISCLAIMER IS BARRED OR LIMITED: https://www.revisor.mn.gov/statutes/cite/524/pdf
5. Gibbs, S.J. (2017, November 2). How an inheritance can jeopardize Medicaid eligibility. Health and Wellness.
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