Disclaimer Planning

Catherine Bright Haws Key Harrington Barnes, P.C. 3710 Rawlins, Suite 950 Dallas, Texas 75219-4469 (214) 884-4817 office (469) 235-2911 mobile (214) 615-7926 facsimile [email protected]

Presented to:

Collin County Probate Section June 10, 2016

Disclaimer Planning Overview

I. Introduction. Disclaimers can This paper will attempt to address the be very powerful tools to accomplish a client's following questions: objectives, though it takes a client with unique 1. What is a disclaimer? planning goals for a disclaimer to be helpful. 2. How does disclaimed property pass? You might even say that a disclaimer is rarely, if 3. Who may disclaim and when is ever, helpful to a client at all in the sense that it court approval or notice required? deprives the client of assets, interests in property 4. What are the remedies for an or powers over property to which he or she was improper fiduciary disclaimer? otherwise entitled and gives the client nothing 5. What are the key legal requirements of value in exchange (no consideration may be of a disclaimer? given to a disclaimant in connection with his 6. What are some of the primary goals decision to disclaim). However, a disclaimer achieved by disclaimers? may nonetheless serve a client's other objectives This paper will also attempt to address these such as: the minimization of federal transfer additional questions at various points taxes, routing assets in a more desirable manner throughout the paper: How might disclaimer (from the disclaimant's perspective) within the provisions be incorporated into estate planning parameters of the estate plan or applicable law, documents to facilitate a client's goals? How the avoidance of certain (but not all) creditor might a disclaimer undermine a client's estate claims, and the prevention of exposure of other planning goals, and when should a disclaimer assets to liability risk associated with an power potentially be curtailed? How might a undesirable asset. disclaimer be used to accomplish the goals of a Disclaimers should be used with extreme client who is not the original owner of the caution and only after the estate planning assets? What ethical implications arise in the attorney has: (1) ensured that the client is well context of disclaimers? informed of the legal consequences and (2) performed key due diligence in connection with II. What is a Disclaimer? There a possible disclaimer, including determining are multiple meanings of a legal "disclaimer" with certainty who will receive the disclaimed but the topic of this paper is the disclaimer property, if the disclaimer is of an interest in (renunciation) of interests in or powers over property. property. Black's Law Dictionary (Free Online Further, if the contemplated disclaimer will Legal Dictionary, 2nd Ed.) defines a disclaimer be by a fiduciary acing in a fiduciary capacity, it as: would be advisable for the disclaimant to notify The disavowal, denial, or the beneficiaries of the intent to disclaim, to renunciation of an interest, right, explain the reasons for doing so and to request a or property imputed to a person release from any liability in connection with or alleged to be his. Also, the doing so, in addition to complying with the legal declaration, or the instrument, by requirements for disclaimer by a fiduciary, which such disclaimer is described further in this paper and in the Texas published…. The act by which a Uniform Disclaimer of Property Interests Act party refuses to accept an estate ("Disclaimer Act"), codified in Chapter 240, which has been conveyed to him. Texas Property Code, effective as of September State Law Meaning of Disclaimer Under the 1, 2015. Disclaimer Act and Applicable Provisions of the Texas Estates Code. Section 240.002(6) of the

Disclaimer Planning – Page 2 Disclaimer Act provides that "[d]isclaimer" result of the death of another person in a manner means the refusal to accept an interest in or that corresponds closely to the definition of power over property. Section 240.002(2) "disclaim" but omits the reference to an interest elaborates on the meaning: the person would be entitled to under an "Disclaim" means to refuse to instrument creating a trust. Only one of the two accept an interest in or power definitions of "beneficiary" refers to property over property, including an the beneficiary is entitled to under the new interest or power the person is transfer on death deed. entitled to: (A) by inheritance; Disclaimer Under IRC 2518. Very (B) under a will; (C) by an commonly, especially prior to the enactment of agreement between spouses for the changes made in the 84th Legislature that community property with a right became effective on Sept. 1, 2015, the term of survivorship; (D) by a joint "disclaimer" was used in reference to a tenancy with a right of survivor- "qualified disclaimer" under Section 2518 of the ship; (E) by a survivorship agree- Internal Revenue Code ("IRC") and associated ment, account, or interest in Treasury Regulations. Although disclaimer which the interest of the decedent planning has been used to some degree for non- passes to a surviving beneficiary; tax reasons, tax-motivated disclaimers seem to (F) by an insurance, annuity, be far more prevalent than other disclaimers. endowment, employment, de- With fewer individuals being subject to federal ferred compensation, or other transfer taxes, tax-motivated disclaimers may contract or arrangement; (G) become less common. Some of the tax benefits under a pension, profit sharing, of a qualified disclaimer are discussed further thrift, stock bonus, life insurance, below in this paper. survivor income, incentive, or Assignment or Disclaimer? The other plan or program providing disclaimer provisions under Chapter 122 of the retirement, welfare, or fringe Estate's Code make it clear that "[a] person who benefits with respect to an is entitled to receive property or an interest in employee or a self-employed property from a decedent under a will, by individual; or (H) by an inheritance, or as a beneficiary under a life instrument creating a trust. insurance contract, and does not disclaim the Other relevant terms, such as "disclaimed property under Chapter 240, Property Code, interest" and "disclaimant," are also defined in may assign the property or interest in property Section 240.002. to any person." Sec. 122.201. It is perhaps Provisions relating to the disclaimer of unclear under Chapter 122 whether a disclaimer property that the disclaimant would entitled to that does not meet the requirements of the receive as a result of the death of another person Disclaimer Act is necessarily an assignment. can be found in Chapter 122 of the Texas However, the statute is clear that "[a]n Estates Code, entitled "Disclaimers and assignment under this subchapter is a gift to the Assignments." Chapter 122 contains two almost assignee and is not a disclaimer under Chapter identical definitions of the term "beneficiary" as 240, Property Code." Sec. 122.205. In other the result of two different bills with the same words, a beneficiary who fails to comply with effective date amending Section 122.001. Both the requirements of the Disclaimer Act has not amendments define the term to include a person made a disclaimer, may have assigned his who would have been entitled, if the person had property interest, and if he has assigned his not made a disclaimer, to receive property as a interest, he has made a gift. The treatment of a

Disclaimer Planning – Page 3 non-conforming disclaimer as a gift would be restrict a power only partially (e.g., by consistent with the federal transfer tax treatment disclaiming a withdrawal right over a trust of a disclaimer that does not comply with the except to the extent the right can lapse pursuant requirements for a qualified disclaimer. to the "$5,000 by 5%" rule of IRC 2514(e)). Disclaimers Apply Not Only to Property The current statute includes a rule permitting a But Also to Powers. As is apparent from the surviving spouse to disclaim property passing to definition of the term "disclaimer," disclaimers the spouse in one form, while retaining other relate not only to specific interests in property interests that the spouse may have in the (such as the right to own a particular asset or a disclaimed property. "A disclaimer by a right to income or principal distributions under a decedent's surviving spouse of an interest in trust agreement) but also to powers (such as a property transferred as the result of the death of power of appointment, a withdrawal power, or the decedent is not a disclaimer by the surviving powers held by a trustee). An attorney who spouse of any other transfer from the decedent understands the legal and tax consequences of to or for the benefit of the surviving spouse, powers over property and how to use regardless of whether the interest that would disclaimers to negate unintentional have passed under the disclaimed transfer passes consequences can in some cases make important because of the disclaimer to or for the benefit of corrections to an estate plan after the estate plan the surviving spouse by the other transfer." Sec. can no longer be changed by the client. For 240.058. This rule comports with the spousal example, a disclaimer of a power as trustee to disclaimer exception under IRC Sec. 2518. make distributions in excess of a health, maintenance, support and education standard, III. How does disclaimed property which power would inadvertently cause pass? An important rule to remember is that inclusion of the trust property in the trustee's disclaimed property passes without any taxable estate or result in taxable gifts in certain direction from the disclaimant. Rather, situations, can accomplish favorable transfer tax applicable law determines who receives the results while facilitating a client's other disclaimed property. The legal effect of a important objectives, such as allowing the client disclaimer depends on the particular to retain control over distributions as trustee. circumstances of the disclaimer, but generally Without the disclaimer, the client might speaking, the effect of a disclaimer of an interest otherwise be required to decline to serve as in property is that the disclaimed property trustee or perhaps seek a more cumbersome passes according to the following rules (there remedy, such as a judicial reformation of the are exceptions to some of these rules, so it is trust. It may also be beneficial for a person to imperative that the attorney review the disclaim a power for non-tax reasons, such as to Disclaimer Act in its entirety rather than rely on prevent creditors from reaching the assets that this list): would be subject to the power.  A disclaimed interest passes Partial Disclaimer. The Disclaimer Act according to any provision in the instrument expressly permits a partial disclaimer. creating the interest that provides for the According to the statute, a partial disclaimer disposition of the interest if the interest were "may be expressed as a fraction, percentage, to be disclaimed or the disposition of monetary amount, term of years, limitation of a disclaimed interests in general. Sec. power, or any other interest or estate in the 240.051(d). property." Sec. 240.009(b). Partial disclaimers  If the instrument creating the are appropriate if a person wishes to relinquish disclaimed interest does not contain such a only a portion of the interest in property, or to provision, the disclaimed interest passes as

Disclaimer Planning – Page 4 if the disclaimant did not exist (in the case possession or enjoyment. Sec. 240.0511(c) of a non-individual) or as if the disclaimant and Sec. 240.0512(c). had died immediately before the time as of  An interest in survivorship which the disclaimer takes effect (in the case property disclaimed by a surviving holder of of an individual). Sec. 240.051(e). the property passes as if the disclaimant  For non-trust property, a predeceased the holder to whose death the disclaimer generally results in the disclaimer relates. Sec. 240.052(c). disclaimed property passing by  A disclaimed interest that passes representation to the descendants of the by intestacy passes as if the disclaimant died disclaimant who survive the decedent (in the immediately before the decedent. Sec. case of property passing because of a 240.051(f). decedent's death) or to the descendants of Although the Disclaimer Act expressly the disclaimant who are living at the time of addresses when a disclaimer of an interest in the event that causes the interest to pass (in property by an appointee of a power of the case of property passing because of an appointment or by an object or taker in default event not related to the death of a decedent). of an exercise of a power of appointment takes Sec. 240.0511(a) and Sec. 240.0512(a). effect (in the first case, as of the time the This is true even if the disclaimed interest instrument by which the holder exercises the would have passed to the disclaimant's power becomes irrevocable, and in the second estate under other provisions of the case, as of the time the instrument creating the Disclaimer Act. Id. power becomes irrevocable), it does not  For trust property, a disclaimer expressly state what happens to property causes the interest to not pass into the trust. disclaimed by an appointee or a default taker. Sec. 240.053(a). If the instrument creating Presumably these would be considered to be the disclaimed interest does not contain a disclaimers of preceding interests and the provision that provides for the disposition of holders of future interests in such disclaimed the interest if the interest were to be property, as described in the instrument creating disclaimed, the disclaimed interest passes as such power of appointment, would receive the if: (1) all of the current beneficiaries, property. presumptive remainder beneficiaries, and Mistake as to Effect of Disclaimer. contingent beneficiaries of the trust affected Navigating the rules relating to the disposition by the disclaimer who are individuals died of disclaimed property can be challenging, yet before the trust became irrevocable; and (2) the importance of reaching a correct conclusion all beneficiaries of the trust affected by the is paramount. An otherwise valid disclaimer disclaimer who are not individuals ceased to that was made under a mistaken understanding exist without successor organizations and as to who would receive the property disclaimed without substitution of beneficiaries under is nonetheless likely to be considered effective the cy pres doctrine before the trust became and irrevocable. Nw. Nat. Cas. Co. v. Doucette, irrevocable. Sec. 240.053(c). 817 S.W.2d 396 (Tex. App.—Fort Worth 1991,  On the disclaimer of a preceding writ denied). But see McCuen v. Huey, 255 interest, a future interest (which is a defined S.W.3d 716, 722 (Tex. App.—Waco 2008, no term, see Sec. 240.0501) held by a person pet.). Section 240.009(c) of the Disclaimer Act other than the disclaimant takes effect as if provides that a disclaimer is irrevocable on the the disclaimant had died immediately before later of the date the disclaimer is delivered or the decedent, but a future interest held by filed as provided in the Disclaimer Act and the the disclaimant is not accelerated in date that it takes effect.

Disclaimer Planning – Page 5 IV. Who May Disclaim and When 240.007 (disclaimer of power). However, a Is Court Approval or Notice Required? fiduciary acting in a fiduciary capacity will not Disclaimer by Non-Fiduciary. "A have a power to disclaim if the fiduciary's right person other than a fiduciary may disclaim, in to disclaim is expressly restricted or limited by whole or in part, any interest in or power over other Texas law (including laws imposing property, including a power of appointment." fiduciary duties) or by the instrument creating Sec. 240.006. This long-standing rule has the fiduciary relationship (e.g., the trust traditionally been the primary basis for agreement or will that creates the fiduciary disclaimers of property interests. The statute relationship prohibits the trustee's or executor's does not require court approval of a disclaimer disclaimer). Id. Note that the instrument that by a non-fiduciary. creates the fiduciary relationship may not be the Disclaimer by Fiduciary. In addition, instrument that creates the property interest. Texas law now provides a new statutory E.g., a decedent's own will appoints his executor framework for disclaimer by a fiduciary and/or trustee, a court appoints a ward's (trustee, guardian, executor, etc.) of any interest guardian and a power of attorney document in or power over property, including a power of appoints the principal's agent. A restriction in a appointment and the power to disclaim, that will that prohibits an agent from disclaiming would have passed to the ward, estate, trust, or property on behalf of a devisee would not be principal with respect to which the fiduciary effective to prevent such a disclaimer. Perhaps was acting had the disclaimer not been made. provisions in the authorizing documents Sec. 240.008. Disclaimers by certain fiduciaries requiring that fiduciaries obtain court approval were permitted under prior law, either with or in connection with disclaiming property should without court approval. See, e.g., former Texas be more commonplace. Probate Code Sec. 37A (2011). However, It appears to be permissible to prohibit commentators have said that prior to enactment fiduciary disclaimers of property interests of the current statute, it was not clear whether generally, or to prohibit disclaimers by a Texas law permitted disclaimer by a Trustee. specific person acting as a fiduciary, or to However, in TAM 8549004, the IRS concluded prohibit disclaimers of specific assets, or to that a trustee had no authority under Texas law prohibit disclaimers of certain beneficiaries' to disclaim trust property on behalf of the trust interests. It should also be permissible to beneficiaries, but rather the beneficiaries restrict a disclaimer by a fiduciary for any themselves held the power to disclaim their reason other than a specifically authorized interests, which is a view shared by some reason, such as to achieve significant tax attorneys in Texas, including the author of this savings or to divert problematic assets from a paper. trust or estate. Finally, a disclaimer could be Curtailing Ability of Fiduciary to prohibited if the asserted reason for the Disclaim Property Interests. The Disclaimer Act disclaimer was a specifically prohibited reason, now authorizes a disclaimer by a fiduciary such as to prevent the disqualification of a acting in a fiduciary capacity, including a beneficiary for government benefits such as trustee, even if the creator of the interest or Medicaid. These alternatives should be taken power imposed a spendthrift provision or a into consideration when structuring a client's restriction or limitation on the right to disclaim estate plan, or perhaps in determining "default" or an instrument other than the instrument that form provisions applicable to disclaimers by created the fiduciary relationship imposed a fiduciaries. restriction or limitation on the right to disclaim. Court Approval. With certain exceptions Sec. 240.008 (disclaimer of property); Sec. described below, a fiduciary disclaimer does not

Disclaimer Planning – Page 6 require court approval to be effective unless the disclaim or the fact of the disclaimer. The instrument that created the fiduciary relationship author has not researched whether that was the requires court approval. Sec. 240.008(b). The case. (Note that, in the case of a disclaimer of a specific exceptions requiring court approval of a power by an agent, the disclaimer of a power fiduciary's disclaimer (in the absence of a court must be delivered to the principal or the approval requirement contained in the principal's representative, so the principal will instrument that created the fiduciary learn that a power granted to the agent has been relationship) include only the following: disclaimed. Sec. 240.110. The author asserts "(1) a disclaimer by a personal that the principal would be far better served by a representative who is not an requirement that he be provided notice of a independent administrator or disclaimer of property to which the principal is independent executor; entitled.) (2) a disclaimer by the trustee of a Disclaimer by Trustee; Required Notice. management trust created under Section 240.053 provides for a trustee's Chapter 1301, Estates Code; disclaimer of an interest in property that (3) a disclaimer by the trustee of a otherwise would have become trust property. trust created under Sec. 142.005; or Unlike other fiduciaries, a trustee is required by (4) a disclaimer that would result in Sec. 240.008(d) to provide written notice of the an interest in or power over property disclaimer in accordance with Section 240.0081, passing to the person making the or to obtain court approval of the disclaimer. "A disclaimer." Sec. 240.008(c). trustee acting in a fiduciary capacity may The Disclaimer Act does not impose any disclaim an interest in property that would cause requirement that a guardian, agent, or the interest in property not to become trust independent executor or independent property without court approval if the trustee administrator seek court approval in connection provides written notice of the disclaimer to all with a disclaimer. Sec. 240.008(c), Disclaimer of the current beneficiaries and presumptive Act. remainder beneficiaries of the trust." Sec. Notice. The Disclaimer Act also does 240.0081(a). Notice must also be given to the not impose any requirement that a guardian, attorney general if charities are involved. Sec. agent, or independent executor or independent 240.0081(c). Notice need not be given to administrator notify the person to whom certain persons, including a beneficiary who is a fiduciary duties are owed of the disclaimer of an descendant of a beneficiary to whom the trustee interest in property. In the absence of a specific has given notice if the beneficiary and the statutory duty to provide notice, it may beneficiary's ancestor have similar interests in nonetheless be true that fiduciary duties such as the trust and no apparent conflict of interest the duty to disclose important information exists between them. Sec. 240.0081(e)(4). The would require a fiduciary to provide the person requirements of the notice are set forth in to whom fiduciary duties are owed with notice Section 240.0081(f). Among those is the of the intent to disclaim, but such is beyond the requirement that the notice must be given not scope of this paper. later than the 30th day before the date the The lack of a notice requirement in these disclaimer is made. Sec. 240.0081(f)(5). contexts may have been an inadvertent omission Disclaimer by Parent of Minor Child. rather than an intentional grant of authority to The statutory authority for a parent to disclaim fiduciaries to deprive the persons to whom on behalf of a minor child provides a powerful fiduciary duties are owed of their property tool for a parent to re-route assets away from his interests without informing them of the intent to or her children, but this authority could also

Disclaimer Planning – Page 7 create problems for our estate planning clients Remedies for Improper Disclaimer. and their intended devisees/beneficiaries. Section 240.008(g) of the Disclaimer Act Section 240.008(e) of the Disclaimer Act provides that "[p]ossible remedies for a breach authorizes certain disclaimers by parents on of fiduciary obligations do not include declaring behalf of their minor children. an otherwise effective disclaimer void or "In the absence of a court-appointed granting other legal or equitable relief that guardian, without court approval, a would make the disclaimer ineffective." The natural guardian as described by exclusion of equitable relief as a possible Section 1104.051, Estates Code, may remedy for an improper disclaimer may have disclaim on behalf of a minor child been a response to Baker Botts, L.L.P. v. of the natural guardian, in whole or Cailloux, 224 S.W.3d 723 (Tex. App.—San in part, any interest in or power over Antonio 2007, pet. denied), which involved an property, including a power of attempt to impose an equitable trust to restore appointment, that the minor child is the disclaimant to the financial position she to receive solely as a result of would have been in but for the breach of another disclaimer, but only if the fiduciary duty. Although subsection (f) of disclaimed interest or power does not Section 240.008 requires that a disclaimer by a pass to or for the benefit of the fiduciary acting in a fiduciary capacity must be natural guardian as a result of the compatible with the fiduciary's fiduciary disclaimer." obligations – unless a court of competent Without meeting any legal requirement jurisdiction approves the disclaimer – this such as a fiduciary duty or a conflicts test (see, requirement cannot be enforced so as to void a e.g., Sec. 115.013(c)(3) of the Texas Property disclaimer carried out in breach of fiduciary Code, which imposes a conflicts test in duties or to secure other equitable relief for a connection with a minor being legally bound by devisee, ward, principal or other party harmed his parent who represents him), a parent by fiduciary misconduct. Section 240.008(g). apparently has authority to disclaim his minor However, under Section 240.0081(h), if children's interests in property so long as the a trustee makes a disclaimer for which notice is property does not ultimately pass to the provided under such section, "the beneficiary disclaiming parent and so long as the interest does not lose the beneficiary's right, if any, to was a future interest accelerated by another sue the trustee for breach of the trustee's disclaimer. For some planners, the fact that the fiduciary obligations in connection with making minor would receive the interest solely as a the disclaimer. Section 240.008(g) applies to result of another disclaimer provides adequate remedies sought in connection with the alleged protection for the minor child without the need breach." It seems that monetary damages would for a conflicts test, the application of fiduciary be available for a person harmed by an improper principles, or court approval. However, there disclaimer by a fiduciary, but recovery of the seem to be many fairly routine planning disclaimed property (which might be real situations, such as a bypass trust funded by a property important to the family or family disclaimer, which would open the door to a business interests, e.g.) appears not to be parent's ability to disclaim assets on behalf of a possible. Considering the severity of the legal minor child. consequences of a disclaimer to the person to whom fiduciary duties are owed, it seems V. What are the remedies for an especially important that such persons be improper fiduciary disclaimer? granted sufficient advance notice by the

Disclaimer Planning – Page 8 fiduciary of the intent to disclaim and/or court disclaim. (b) A disclaimer of an oversight of any proposed fiduciary disclaimer. interest in property is barred if any of Interestingly, by implication, the statute the following events occur before the validates fiduciary disclaimers that are not disclaimer becomes effective: (1) compatible with the fiduciary's fiduciary the disclaimant accepts the interest obligations, so long as a court approves the sought to be disclaimed by: (A) disclaimer. Although it may seem unlikely that taking possession of the interest; or a court would sanction such a disclaimer, it is (B) exercising dominion and control worth noting that the court could do so, if so over the interest; (2) the disclaimant inclined, or could do so inadvertently by voluntarily assigns, conveys, "blessing" a disclaimer that is in violation of encumbers, pledges, or transfers the fiduciary duties. interest sought to be disclaimed or Attorneys representing persons entitled contracts to do so; or (3) the interest to receive property in any of the circumstances sought to be disclaimed is sold under described in the Disclaimer Act should promptly a judicial sale." notify any fiduciary who proposes to disclaim Sec. 240.151 might be helpful in preventing a the property not to proceed if any concerns disclaimer when concerns exist whether a about the disclaimer exist and should promptly disclaimer might be inappropriately made. A seek relief in the courts. It will be important to written waiver of the right to disclaim may be be diligent in identifying for the court any collected before the disclaimer opportunity breach of fiduciary duty arising in connection arises, which will be effective to prevent a valid with the fiduciary's proposed disclaimer and in disclaimer. For example, a grantor or the preventing the court from allowing an improper beneficiaries of a trust might request a disclaimer to take effect. Ad litems should be fiduciary's waiver of the right to disclaim. especially diligent in understanding and Sec. 240.151 also addresses other key preventing potential irreparable harm that could questions relating to the acceptance of an be caused by a fiduciary disclaimer. interest sought to be disclaimed, which invalidates a subsequent attempted disclaimer as VI. What are the key legal indicated above. First, "[t]he acceptance of an requirements of a disclaimer? interest in property by a person in the person's Disclaimer Requirements. For state law fiduciary capacity is not an acceptance of the purposes, a disclaimer must meet certain interest in the person's individual capacity and technical requirements, apart from the other does not bar the person from disclaiming the requirements discussed in this paper, in order to interest in the person's individual capacity." be effective. Those requirements are set forth in Second, "[a] disclaimer, in whole or in part, of Sec. 240.009(a) and Sec. 240.151 of the the future exercise of a power held in a fiduciary Disclaimer Act. Sec. 240.009(a) states that "a capacity is not barred by the previous exercise disclaimer must: (1) be in writing; (2) declare of the power." Third, "[a] disclaimer, in whole the disclaimer; (3) describe the interest or power or in part, of the future exercise of a power not disclaimed; (4) be signed by the person making held in a fiduciary capacity is not barred by the the disclaimer; and (5) be delivered or filed in previous exercise of the power unless the power the manner provided by Subchapter C." Sec. is exercisable in favor of the disclaimant." 240.151 imposes the following further Finally, Sec. 240.151 explains the effect requirements: of an attempted disclaimer of property or "(a) A disclaimer is barred by a powers that is barred by such Section. In the [prior] written waiver of the right to case of a power over property, the barred

Disclaimer Planning – Page 9 disclaimer is ineffective. Sec. 240.151(f)(1). In Two other important requirements of the case of an interest in property, the barred Treas. Reg. Sec. 25.2518-2 are: disclaimer "takes effect as a transfer of the "A person who receives an interest in interest [ineffectively] disclaimed to the persons property as the result of a qualified disclaimer of who would have taken the interest under the interest must disclaim the previously Subchapter B had the disclaimer not been disclaimed interest no later than 9 months after barred." Sec. 240.151(f)(2). In other words, the date of the transfer creating the interest in even if the disclaimer is barred by reason of the the preceding disclaimant." Treas. Reg. Sec. disclaimant's prior acceptance of the property, 25.2518-2(c)(3). the result of the failed disclaimer attempt is that "The acceptance of any consideration in the property is nonetheless transferred, with return for making the disclaimer is an resulting legal and gift tax consequences, rather acceptance of the benefits of the entire interest than retained by the disclaimant. disclaimed. Treas. Reg. Sec. 25.2518-2 (d)(1)." Federal Tax Rules Applicable to This does not constitute an exhaustive Disclaimers. Treas. Reg. Sec. 25.2518-2(a) lists list of all the requirements for a qualified some of the basic requirements for a qualified disclaimer. disclaimer, which (paraphrased) are: Child Support Obligor Cannot Disclaim. (1) The disclaimer must be An important limitation to a disclaimer by a irrevocable and unqualified; person who is a parent is the Disclaimer Act's (2) The disclaimer must be in prohibition against a child support obligor's writing (the writing must identify the disclaimer of property that could be applied to interest in property disclaimed and satisfy the disclaimant's child support be signed either by the disclaimant or obligations. Sec. 240.151(g) of the Disclaimer by the disclaimant's legal Act. This exception applies to a parent's representative); disclaimer of his own property interests which (3) The writing must be delivered to could be so used and is probably less applicable the transferor of the interest, the in the context of disclaimers made by a parent transferor's legal representative, the on behalf of his minor children. The parent's holder of the legal title to the obligations must have been reduced to judgment property to which the interest relates, or administratively determined by the Title IV- or the person in possession of such D agency, as provided in the Family Code. property, no later than the date which Section 240.151(g). is 9 months after the later of (i) the Section 240.151(h) provides that the date on which the transfer creating child support obligee to whom child support the interest in the disclaimant is arrearages are owed may enforce the child made, or (ii) the day on which the support obligation against the disclaimant as to disclaimant attains age 21); disclaimed property by a lien or by any other (4) The disclaimant must not have remedy provided by law. Does this enforcement accepted the interest disclaimed or provision allow a lien to attach to the disclaimed any of its benefits; and property or only to property that is owned by the (5) The interest disclaimed must disclaimant? Can "any other remedy provided pass either to the spouse of the by law" include other legal or equitable relief of decedent or to a person other than the type that Section 240.008(g) of the the disclaimant without any direction Disclaimer Act precludes? on the part of the person making the The statutory prohibition against disclaimer. disclaimer seems to apply regardless of whether

Disclaimer Planning – Page 10 the child support obligor's resources property in such a manner as to expose it to (disregarding the property the obligor wishes to creditor claims prior to being disclaimed, the disclaim) are adequate to meet his or her child relation-back doctrine, now codified in the support obligations and regardless of whether Disclaimer Act, clarifies that a disclaimer the property would pass to or for the benefit of relates back for all purposes to the time of the the child support obligee if the disclaimer were decedent's death or to the time the instrument allowed to take effect. One can imagine a creating the disclaimed interest became situation in which other creditor claims attached irrevocable or the time of the irrevocable to property that could not be disclaimed, with transfer, as applicable. Sec. 240.051. An the result that the children to whom the would- important limitation on the protection afforded be disclaimant owed child support were by the statute is that a disclaimer made after a deprived of resources that would have passed to federal bankruptcy petition has been filed will them had a disclaimer been permitted. A prior not be effective to remove the disclaimed version of the statute required that a disclaimer property from the reach of creditors. In re include a statement whether the disclaimant was Schmidt, 362 B.R. 318, 326-27 (Bkrtcy W.D. a child support obligor in order for a disclaimer Tex. 2007). to be valid (see former Texas Estates Code Sec. Achieving Transfer Tax Goals. What 122.051(b)), but that requirement seems to have are the tax benefits of a qualified disclaimer for been repealed. federal transfer tax purposes? Generally speaking, properly disclaimed property is VII. What are some of the primary treated for federal transfer tax purposes as goals achieved by disclaimers? though it passed directly from the original Avoiding Creditor Claims. When owner to the ultimate recipient(s) without any representing a beneficiary who is entitled to disclaimant having acquired ownership. I.e., receive an interest in property, one factor to disclaimed property will not be included in the consider is whether the beneficiary owes a disclaimant's taxable estate and will not be significant debt to a judgment creditor or other considered a transfer by gift from the creditor. Generally speaking, non-exempt disclaimant to the ultimate recipient(s). For property owned by a debtor is reachable by a example, if property would pass to a person who creditor to satisfy the debt owed, with the is very wealthy in his own right and who has exception of certain assets that offer some implemented or will need to implement estate measure of protection for the owner, such as planning strategies to minimize federal estate interests in a limited partnership or limited taxation in his own estate, such a person might liability company (with such assets, a creditor is disclaim the property so that it can pass to the likely limited to a charging order). alternate, contingent or remainder beneficiaries Two key features of the Disclaimer Act without being subject to transfer taxes. Often operate to protect disclaimed property from those beneficiaries are the disclaimant's creditors of the disclaimant. First, Sec. 240.051 descendants. Some of the requirements for a of the Disclaimer Act provides that a qualified disclaimer for transfer tax purposes are "disclaimed interest is not subject to the claims discussed in further detail above. of any creditor of the disclaimant." With the "Decoupling" the State Law Disclaimer exception of a child support claim against a from the IRC's Qualified Disclaimer child support obligor (discussed elsewhere Requirements. Prior versions of the Texas herein), disclaimed property is expressly disclaimer laws were often oriented toward protected from claims. Second, even though a preserving the federal transfer tax benefits of person may be legally entitled to the disclaimed disclaimers. One of the most notable tax-

Disclaimer Planning – Page 11 motivated state law requirements was the Disclaimer of Property Interests Act (Draft requirement that a disclaimer be made within dated May 27, 2014) is for a trustee of a trust for nine months of a transfer, although the Texas the benefit for a surviving spouse who also has and IRC nine-month requirements did not the power to invade principal for the decedent’s correspond perfectly as explained by Glenn M. descendants to disclaim the latter power in order Karisch and Julia E. Jonas in their paper entitled to qualify the trust for the marital deduction, if "Problems with the Texas Disclaimer Statutes the trust otherwise qualifies. The NCCUSL and How to Deal with Them", September 19, Comments cite to Cleaveland v. U.S., 62 2014. The new statute eliminates the nine- A.F.T.R.2d 88-5992, 88-1 USTC ¶ 13,766 month time period and certain other (C.D.Ill. 1988), as an example of an effective requirements that were designed to sync the use of such a disclaimer. state law disclaimer rules with the IRS rules. 2. A relatively common planning strategy The "decoupling" of Texas law from the that utilizes disclaimers is the so-called requirements of qualified disclaimers under "disclaimer bypass trust". A testator might federal law may have been motivated in part by typically provide that his estate passes outright the expected reduction in the number of tax- to his surviving spouse; however, any property motivated, qualified disclaimers as a result of disclaimed by the surviving spouse will pass to the "permanent" increase in the applicable the trustee to be held in a "bypass" trust. This exclusion amount, as well as by the desire to strategy was particularly helpful to some clients take advantage of certain other perceived during 2001-2010, when the applicable credit benefits of the Uniform Disclaimer of Property amount varied greatly from year-to-year, Interests Acts approach. If a qualified causing potentially large shifts in the value of disclaimer is needed to accomplish the client's the shares that a surviving spouse and other tax goals, the attorney must ensure (as we have recipients (such as the children) might receive if always had to do) that the federal law a tax-driven funding formula were used. Now requirements are met and not only the Texas such planning could potentially be effectuated statutory requirements. by a surviving spouse's disclaimer, as well as by Protecting Assets. A disclaimer may be a trustee's disclaimer. one method to prevent liabilities associated with 3. A high net worth client who desires to a "troubled" asset, such as environmentally create a source of funds from which transfers to damaged real property, from attaching to other his children could be made tax-free during his assets. lifetime might consider disclaiming property to Re-Routing Assets. It is sometimes the which the client would be entitled (and which he case that assets would have been structured to is confident that he will never need), if the result pass differently had current facts and is that the client's children would become circumstances been known by the original beneficially entitled to the property following owner of assets, or had the disposition been the the disclaimer. prerogative of a person other than the original 4. A client who is insolvent and whose owner of assets. A beneficiary or a fiduciary inheritance of property would not result in the acting for another person may have some ability satisfaction of all of his creditor claims, leaving to alter certain aspects of the disposition plan for him debt-free and perhaps also with additional assets by making a disclaimer. assets to support his standard of living, may wish to disclaim the property prior to filing a VIII. Disclaimer Planning Examples: bankruptcy petition, allowing the property to 1. A planning suggestion borrowed from pass free of creditor claims to the alternate the NCCUSL Comments to the Texas Uniform recipients (perhaps his descendants). The benefit

Disclaimer Planning – Page 12 of paying one's debts in full should not be children's interests are disclaimed. What if the undervalued in considering this option. parent's goal is to keep the assets from the 5. A client who qualifies for Medicaid or control of a former spouse who would be trustee other government benefits and who might not of the assets if not disclaimed and who might be benefit from the ability to potentially enjoy a able to use the disclaimed funds to maintain a higher standard of living as a result of an better lifestyle for himself or herself? It appears inheritance might elect to disclaim the property that a parent may disclaim property passing to interest in order to remain eligible for such his minor children regardless of whether the benefits. However, there are very significant disclaimer is self-serving, so long as the parent differences in the quality of care that a Medicaid so disclaiming does not receive the property as a recipient and a person who has adequate result of the disclaimer. resources to pay for his own care typically receive. Accordingly, although a disclaimer by IX. Summary: such a person is appropriately such person's Throughout this paper are examples of decision to make (whether prudent or not), a situations in which a disclaimer might be fiduciary acting for such a person should helpful or detrimental to the interests of various exercise extreme caution – and make sure the individuals who would be affected by a decision to disclaim is truly in the best interests disclaimer. It is incumbent upon us as attorneys of the disclaimant – before disclaiming property to advise our clients competently regarding not that could provide meaningful help to the person only the availability of disclaimers to to whom the fiduciary owes duties. accomplish a client's articulated goals and the 6. A surviving spouse who has adequate legal consequences of disclaimers, but also financial resources for his own support may regarding the legal duties and procedural wish to disclaim all of his interests in assets requirements such as notice that must be passing from his deceased spouse, allowing considered and complied with. those assets to pass to or in trust for the benefit Various concerns of the author relating of children, grandchildren, or others as the case to how disclaimer powers held by a fiduciary may be. If the deceased spouse left the assets could be abused, especially in light of outright to the surviving spouse, a disclaimer potentially inadequate legal remedies for those might make better use of the decedent's wasted harmed by the disclaimer, were also raised. GSTT exemption, for example. Although the law may grant a fiduciary the 7. A parent who wishes to prevent his power to disclaim, perhaps without notice or (currently) minor child from receiving assets court review, and perhaps in a manner that is not could disclaim property passing to or for the entirely consistent with fiduciary duties, the benefit of his child, if the child would himself attorney should advise a fiduciary client of the receive the interest in the property as a result of legal risks associated with failing to give notice, another disclaimer. Perhaps the parent has very get beneficiary consent (and perhaps a release, if noble objectives in making a disclaimer, such as such a release does not trigger undesirable tax a desire to keep the assets from a child with a consequences), confirm the validity of the substance abuse problem or who the parent proposed disclaimer in court or take other steps believes is likely to be dependent on trust to ensure the fiduciary's disclaimer is money for support. Perhaps the parent has a appropriate. less noble motive for disclaiming on behalf of Although the Disclaimer Act clarifies his minor children, such as facilitating a that "[a] disclaimer by a fiduciary acting in a distribution to a current spouse who becomes fiduciary capacity is not a per se breach of the the owner or beneficiary of the assets if the fiduciary's fiduciary obligations," it is equally

Disclaimer Planning – Page 13 clear that a disclaimer by a fiduciary will very often (almost always in the author's view) constitute a breach of fiduciary duty. Even if tax savings, avoidance of creditor's claims, qualification for government benefits or some other benefit can be achieved by a disclaimer, the disclaimer may substantially and adversely affect the rights of the (or of a) person to whom the fiduciary owes fiduciary duties. It is perhaps best in most cases to leave the decision whether to disclaim to the disclaimant rather than to disclaim interests as a fiduciary. That being said, a fiduciary who is armed with the reassurance provided by informed consent can wield this powerful tool to great effect.

This paper is provided for educational purposes only and does not constitute legal advice by the author or the author's law firm.

The author would like to acknowledge having studied an excellent paper authored by Glenn M. Karisch and Julia E. Jonas, entitled "Problems with the Texas Disclaimer Statutes and How to Deal with Them", September 19, 2014, as well as materials prepared by other knowledgeable authors or presenters, in connection with writing this paper. The authors of other such materials were not consulted in connection with this paper and have not reviewed or verified the accuracy of its conclusions or suggestions.

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