Mr. Katz executed a will in 1991 that called for the creation of a "pecuniary credit shelter trust" equal to the amount of the "aggregate federal estate tax exemption equivalent." The will language further provided that the credit shelter trust "shall not be reduced on account of any disclaimer by my wife." Finally, another provision in the will stated conflicting provision in this will, "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 Mr. Katz's will was to place an amount equal to the amount that can pass free of estate tax into trust so that it would eventually pass to his children without being subject to estate taxes in his wife's estate.

The effect of a qualified disclaimer is to treat the disposition of the asset disclaimed as if the disclaimant had predeceased, thereby causing the asset to be distributed to the contingent beneficiary under the will, trust, retirement plan, life insurance or other document controlling the disposition of the asset. If there is is no controlling document, the asset would be distributed to the next person in line under the intestacy laws of the decedent’s state of residence. Internal Revenue Code section 2518 provides that a qualified disclaimer must: (1) identify the property being disclaimed, (2) be in writing, (3) be signed by the disclaimant, (4) be an irrevocable and unqualified refusal to accept the interest in the property, (5) be made within nine months after date of death of the owner of the property, (6) be made prior to the disclaimant’s acceptance of the disclaimed interest or any of its benefits, and (7) must pass the disclaimed property without any direction on the part of the disclaimant.

Upon Mr. Katz’s death in 1998, the amount that could be passed free of estate tax was $625,000. Apparently Mrs. Katz felt she had no need to access any of the funds being transferred to the credit shelter trust under her husband’s will, so she disclaimed her interest in the credit shelter trust. This means that the assets allocated to the credit shelter trust would pass immediately to Mr. Katz’s children under the terms of the trust.

In addition to disclaiming her interest in the credit shelter trust, Mrs. Katz also disclaimed her interest in a designated number of shares of five different securities owned by her husband. At trial, her lawyer explained that Mrs. Katz’s disclaimer of these securities was for the purpose of directing which assets she was disclaiming in association with the funding of the credit shelter trust.

The IRS argued that Mrs. Katz disclaimed both her interest in the $625,000 allocated to the credit shelter trust as well as her interest in the five securities – therefore an estate tax was due of the value of the securities disclaimed since the value of all assets disclaimed was in excess of the amount that could be passed free of estate tax. The estate argued that Mrs. Katz only intended to disclaim $625,000 worth of assets.

The Tax Court in Estate of David Katz v. Commissioner, T.C. Memo 2004-166, held that the language of the will was clear – the credit shelter trust was to be funded with $625,000 and any disclaimer by Mrs. Katz was not to reduce this amount, instead any amount disclaimed was to be added to the credit shelter trust. Therefore, the Tax Court held for the IRS.

In this case, the executor of Mr. Katz’s will could have allocated the designated securities to the credit shelter trust without an additional disclaimer by Mrs. Katz and the estate tax imposed by the IRS could have been avoided. This is a perfect example of why it is so critically important to hire an attorney who focuses in estate planning to assist your clients with their estate and trust administrations. Here, a simple mistake by Mrs. Katz cost her children hundreds of thousands of dollars in estate taxes that would have ultimately been avoided but for the errant disclaimer. Contact us to schedule a complimentary appointment for yourself or your client.