Nonqualified Disclaimers to a Charity as a Planning Technique

Posted on October 3, 2021

After your exceedingly long discussion with Uncle Bill a few weeks ago regarding his FBAR filing requirements, there has been total radio silence between you and Bill—not that you mind it in the least bit. The first day of fall came and went, but apparently no one told Florida. It was 85° outside on September 22^nd, and though a discolored oak leaf fell onto the hood of your car, you suspected that it was the gold-spotted oak borer (Agrilus coxalis) rather than the changing of the seasons. Little flatheaded bastards.

In the bottom of the second inning of your eight-year-old son’s first baseball game of the year, your pocket begins to buzz, and sure enough, Uncle Bill’s name pops up on the caller ID. You let the call roll to voicemail, and you are surprised five minutes later when the phone buzzes again letting me know that Bill has left an inordinately long message for you.

In short, there have been some developments with Great Aunt Hilda’s estate administration in the ten months since her death, particularly with an irrevocable trust that she set up for Bill, his daughters, and the National Historic Cheesemaking Center in Monroe, Wisconsin—about three hours southwest of Sheboygan, where she had been living with her paramour, Wilhelm Müller, a childhood friend from the hinterland. After your son strikes out for the third time, you take the opportunity to call Bill.

Your uncle explains that Hilda set up the trust so that Bill would receive all income for life, and at his death to separate trust would be set up for the benefit of Bill’s daughters, Jennie and Jaime. After Jennie and Jaime shuffle off their mortal coil, the remainder of the trust would pass to the national cheesemaking center, the veritable center of the cheesemaking world.

Disclaiming an Interest in a Trust

With all of Bill’s success in the flightless bird business (emus, ostriches, and cassowaries, oh my), he does not need the income from the trust, and he wants to give whatever income he would have received from the trust to his two daughters. Jennie and Jaime, however, are afraid that the money could cause untoward tax consequences, especially given their unusually large income this year—Jennie from selling off some of her Amazon stock, and Jaime from the settlement of the personal injury claim that she had against the International House of Pancakes. (It turns out that though sticky, in large enough puddles, butter pecan syrup is quite slippery.)

You explain to Bill that the only way to “give away” his income interest in a trust, without reforming it in some way (like decanting) would be to disclaim his interest in the trust, which would effectively terminate his interest. Under the Internal Revenue Code, specifically under IRC § 2518, a beneficiary of an interest in property may make a qualified disclaimer within nine months from the date on which the transfer creating the interest in the person is made.[1]

If a disclaimer is qualified, the transfer tax consequences of the disclaimer are such that the disclaimant is treated as if the interest in the property had never been transferred to him.[2] Instead, the property is considered as passing directly from the transferor of the property to the person entitled to receive the property as a result of the disclaimer.[3] Accordingly, a person making a qualified disclaimer is not treated as making a gift.[4] Thus, if Bill had made a qualified disclaimer, the income of Hilda’s trust would pass directly to Jennie and Jaime.

Nonqualified Disclaimers to a Charity as a Planning Technique

If the disclaimer is not a qualified disclaimer—for the purposes of the Federal estate, gift, and generation-skipping transfer tax provisions—the disclaimer is disregarded and the disclaimant is treated as having received the interest.[5] Because Bill’s disclaimer would be made more than nine months after Great Aunt Hilda’s death, it would not be a “qualified” disclaimer.[6]

You explain that practically speaking, the non-qualified disclaimed property becomes part of the Bill’s gross estate. Any subsequent transfer for less than full consideration would, therefore, be considered a taxable gift by the dilatory disclaimant to the subsequent donee, rather than a gift from the original donor (here, Hilda).

Charitable Donation by Disclaimer

Under these circumstances, Bill would not be considered to have made a gift to charity. If Bill disclaims its lifetime interest in the trust, the disclaimed interest passes to the successor beneficiaries, Jennie and Jaime. Thus, Bill’s gift of his lifetime interest would be a split gift between Jennie and Jaime.

If Jennie and Jaime were to later make a nonqualified disclaimer of their income interest in their separate trusts, then Jennie and Jaime would be making a gift directly to the cheese charity, or a donation, as it were, of the present value of their income interest.[7] In this case, the actuarial tables described under IRC § 7520 should be referenced to determine the value for gift tax purposes. The actuarial tables for life income interests are set out in IRS Publication 1457.

Obviously, if Jennie and Jaime are not the same age, the gifts of their lifetime interests would not be equal, but because the disclaimers are from separate trusts, we don’t have to worry about last-to-die factors, or any of that other nonsense. It should be noted that the value of the charitable donation would be reduced by any gift tax to be paid under IRC § 2512(b).[8]

There is an ever-present concern, due to his propensity for seriously injuring himself and his penchant for taking drunken joyrides on his John Deere riding lawnmower, that under IRC § 2035 the value of Bill’s gift would be includible in the value of his estate if he were to die within three years of the disclaimer/gift.

You ask Bill whether Jennie or Jaime have any affiliation with the national cheese museum, and he laughs. He explains that they are both lactose intolerant, and you take this as a no. You asked, because there are a number of private letter rulings dealing with disclaimers to charities in which the disclaimant has an affiliation, such as IRC § 501(c)(3) entities in which the disclaimant is a director, trustee, officer, executive, or other employee. The IRS has consistently held that there are additional steps necessary to “distance” the disclaimant from control over the disclaimed property with respect to the charity under IRC § 2518(b)(4).[9]

**The Christensen Case**

The Tax Court has not directly weighed in on the issue of nonqualified disclaimers and charitable deductions for purposes of income tax. The closest that the Tax Court came was the 2008 opinion of Estate of Christensen v. Commissioner,[10] in which it examined the partially unqualified disclaimer of a decedent to a charity vis-à-vis the estate tax charitable deduction.

In Christensen, the IRS argued that the partial qualified disclaimer was not effective to permit the estate to take a charitable deduction, because the disclaimed interest was not transferred “by the decedent during his lifetime or by will” as required by IRC § 2055 and Treas. Reg. § 20.2055-1(a), but it was instead disclaimed by the decedent’s daughter after the decedent’s death.

Nevertheless, the Tax Court permitted the estate to take a charitable deduction based on the fact that by means of a qualified disclaimer, the disclaimant was treated as predeceasing her mother, and therefore the interest passed by operation of the decedent’s testamentary documents. In so finding, the Tax Court observed that “Public policy encourages gifts to charity, and Congress allows charitable deductions to encourage charitable giving.”[11]

Christensen illustrates the Tax Court’s broad application of charitable giving rules, especially when it comes to charitable donations made through the mechanism of a disclaimer. There is a silence at the end of the line, and you have the urge to remind Bill that you cannot hear him nodding his head through the phone, but you decide to let it go, lest he tries to Facetime you.

Another interesting riff on the nonqualified disclaimer subject is found in IRS PLR 200602031, in which a wife made a nonqualified disclaimer of QTIP property to a charitable trust over which she was trustee. The IRS ruled that because the wife was the trustee of the charitable trust, the nonqualified disclaimer was not a completed gift under IRC § 2501. Reading between the lines, had the wife not been the trustee of the charitable trust, or had the wife’s unqualifiedly disclaimed interest passed directly to the charity, the gift would have been complete under IRC § 2501.

Bottom Line: The nonqualified disclaimer of Jennie and Jaime’s respective lifetime income interests in their trusts in favor of a charity would be considered a charitable donation, and the value of the donation would be equal to the present value of their income interest in the two trusts.

Totally Unrelated, but Brilliant Uses of Nonqualified Disclaimers

In IRS PLR 9550041, a surviving spouse made a nonqualified disclaimer of funds coming from the decedent’s retirement plan—and, in turn, the alternate beneficiaries also disclaimed their interests. Because the funds then passed to the widow by intestacy, instead of through the estate (the estate was the deceased’s retirement plan beneficiary), the net effect was the funds that passed to the wife qualified for rollover (generally, if plan assets pass through a third party—including a trust or estate—they will not be eligible for rollover) and, because the property returned to her, her nonqualified disclaimer was not considered a taxable gift.

In IRS PLR 200901013, the IRS determined that while a qualified disclaimant is not treated as making a gift (the property is deemed to have passed directly from the disclaimant’s transferor to the person who receives it due to the disclaimer), where a person makes a nonqualified disclaimer, the property transferring to the person entitled to receive it is considered to be a gift made by the disclaimant.

This device can be used to restructure a trust that might otherwise have generation-skipping transfer (GST) implications—such as where the trust is for the benefit of both the grantor’s children and grandchildren. In this case, if the children make nonqualified disclaimers of their interests, they may thereby become the “grantors” with respect to the grandchildren, thus avoiding the generation-skipping transfer tax.

Bill thanks you heartily, and you return to the sunny side of the bleachers to watch eighteen eight-year-olds throw the ball in every conceivable direction except where they meant to. You hope that your son inherited some of your intelligence, because there is a snowball’s chance in hell that he’s getting an athletic scholarship anywhere of distinction.