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It's time to dust off our old friend, the disclaimer trust

In moderately sized estates and happy family situations, a disclaimer trust is likely to be the right answer to the tax planning dilemma.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 set the tax-free amount for persons dying in 2011 and 2012 at $5 million. The 2010 act also introduced "portability" -- if the proper procedures are followed, the surviving spouse may use the unused tax-free amount of the first spouse to die.  The 2010 act leaves us hanging, however, since the tax-free amount drops to $1 million and portability goes away in 2013 unless Congress extends the new law.

In this environment, what sort of estate tax planning makes sense for married couples with moderate wealth?

Problems with portability

At first glance, there seems to be no reason for most couples to do bypass trust planning because of portability.  If the surviving spouse gets to use the unused portion of the tax-free amount of the first to die, then why go to the trouble and expense of having a bypass trust?  (For an explanation of basic bypass trust planning, download this paper by Glenn Karisch from

When looking deeper, the problems with portability become apparent:

  • Most significantly, portability ends in 2013 unless Congress extends it.
  • In order to use portability, the executor of the estate of the first spouse to die must file an estate tax return to establish the amount of the unused tax-free amount.  It will be expensive to prepare and file this return, and the return is unnecessary except for portability.
  • Remarriage could jeopardize the use of the portability amount.  A decedent may use the unused tax-free amount of his or her most-recently-deceased spouse.  If Wife 1 dies with unused tax-free amount, then Husband marries Wife 2, who then dies, the portability amount of Wife 1 is lost.
  • Portability does not shelter the appreciation of property from tax.  If property appreciates between the deaths of the spouses, that appreciation is taxed in the estate of the surviving spouse, while it could be sheltered from tax in a bypass trust. 

Problems with formula-funded bypass trusts

Using a bypass trust funded by a formula intended to maximize the property placed in the trust avoids most of the problems caused by portability, but it creates other problems:

  • The formula provisions are tricky to draft when there are fundamental changes in the estate tax laws.  A poorly drafted provision may put too much or too little in the trust.  Even a well-drafted provision may have an unintended result.
  • Couples with estates in the $1 million to $5 million range may face bigger problems with the capital gains tax than the estate tax.  Property placed in the bypass trust at the death of the first spouse does not get a step-up in basis when the surviving spouse dies.  If it turns out that the bypass trust wasn't needed for estate tax savings, the family will pay more capital gains tax than otherwise might have been necessary.
  • Formula-funded bypass trusts must be funded.  There's no way to avoid creation of the trust if, at the time of the death of the first spouse, the trust seems unnecessary or ill-advised. 

Enter the disclaimer trust

A bypass trust funded by disclaimer may fill the bill for many married couples. Here's how disclaimer trusts work:

  • Each spouse's will leaves all property to the surviving spouse.
  • Each spouse's will provides that, if the surviving spouse disclaims any property, the disclaimed property will pass into a bypass trust.

A special rule that applies only to spouses permits the spouse to disclaim property into a trust of which the spouse is a beneficiary.  Internal Revenue Code Section 2518(b)(4)(A).  Therefore, the spouse may be a beneficiary of the trust.  If the trustee's power to make distributions is limited by an ascertainable standard like "health, education, maintenance and support," then the surviving spouse may be the trustee of the trust.  If the beneficiary designations on life insurance and retirement plans are coordinated properly, the surviving spouse may disclaim some or all of these assets, causing them to go into the bypass trust.

The disclaimer trust permits deferring the decision about whether or not to have a bypass trust until after the death of the first spouse to die.  With the volatility of the law and the economy, this might be the best time to decide whether or not estate tax planning is needed.  Also, a couple may appear to have no estate tax worries now, but increases in wealth may push them into needing a trust.  The disclaimer trust makes an excellent back-up estate tax plan.

Disclaimer trusts have problems, too

Disclaimer trusts have their own set of problems and are only appropriate in certain situations.  Here are some of the problems which may arise:

  • A disclaimer cannot be made if the persons wishing to disclaim has accepted the interest or any of its benefits.  Internal Revenue Code Section 1518(b)(3).  If the spouse mistakenly takes control of an asset -- switches a brokerage account into his name, cashes in a life insurance policy, etc. -- that asset cannot be placed in the trust.
  • The disclaimer must be made in the proper form within 9 months of the decedent's death.  Internal Revenue Code Section 2518(b)(2).  A spouse who is asleep at the switch may miss the opportunity to fund the bypass trust.  (There's a special extension of the 9-month disclaimer deadline for persons who died between January 1, 2010, and December 17, 2010.  See the 2010 tax law for details.)
  • A disclaimer-funded bypass trust only works if the surviving spouse disclaims. A grieving spouse may be unwilling or unable to make a timely disclaimer.  If the remainder beneficiaries of the bypass trust are the surviving spouse's stepchildren, the surviving spouse may decide not to disclaim (and, in fact, is very, very unlikely to decide to disclaim) because he or she does not wish to be exposed to accounting demands and other actions of the stepchildren.
  • In a formula-funded bypass trust, the surviving spouse may be given a special power of appointment so that he or she may control the disposition of the trust property at death.  The surviving spouse may not be given a power of appointment over a disclaimer-funded bypass trust. This means that the disposition is locked in at the time of the first spouse's death.  This creates two problems:
    • The surviving spouse cannot tweak the plan.  For example, the surviving spouse cannot direct the bypass trust property into a GST trust.
    • The surviving spouse cannot appoint the property away from an interfering remainder beneficiary.  The power of appointment can be an effective tool for dealing with uncooperative remainder beneficiaries, but it is unavailable with disclaimer trusts.
  • A disclaimer is ineffective for Medicaid planning purposes.  The surviving spouse may not exclude assets from consideration for Medicaid eligibility by disclaiming them into a bypass trust.

Keep all of your tools sharpened

In times of changing tax laws and a fluctuating economy, estate planners must be ready to use different techniques.  There are fewer "once size fits all" plans these days.  A disclaimer trust can be an effective tool for many married couples, but in most cases only if they have no children by prior marriages.


Estate Planning and Community Property Law Journal Seminar at Texas Tech February 18

The 2011 Estate Planning and Community Property Law Journal CLE Seminar will be held Friday, February 18, 2011, at the Texas Tech University School of Law in Lubbock.  Among the speakers and topics are:

  • Tom Featherston on non-probate property and probate dispositions of community property
  • Anne-Marie Rhodes on issues in planning and drafting when an estate includes works of art
  • Gerry Beyer on common non-tax errors in estate planning and how to prevent them
  • Judge Polly Spencer, Susan Staricka and Susan Fortney on charities as beneficiaries
  • Joshua Rubenstein on controlling the disposition of one's remains and posthumous use of genetic material
  • Stanley Johanson on recent tax developments in estate planning
  • William LaPiana on the elective share

For more information, see Gerry Beyer's post on the Texas Probate Mailing List or the Estate Planning and Community Property Law Journal website.


Perpetuities: How about 200 years?

The Wealth Management and Trust Division of the Texas Bankers Association (the TBA) has tried to repeal or extend the rule against perpetuities as it applies to trusts in past sessions, and it appears that it is going to try again.  HB 372 and SB 261 would amend Section 112.036 of the Texas Trust Code to permit trusts to last for 200 years.

Will Hartnett, Author of HB 372

The companion bills were filed by Rep. Will Hartnett (R-Dallas) and Sen. John Carona (R-Dallas).

Like most states, Texas follows the traditional rule against perpetuities.  The rule is codified in Section 112.036 of the Texas Trust Code:

The rule against perpetuities applies to trusts other than charitable trusts. Accordingly, an interest is not good unless it must vest, if at all, not later than 21 years after some life in being at the time of the creation of the interest, plus a period of gestation. Any interest in a trust may, however, be reformed or construed to the extent and as provided by [Property Code] Section 5.043.

In the past 15 years, several states have either abolished the rule against perpetuities or greatly extended the permissible duration of trusts.  Ironically, it was the enactment of the generation-skipping transfer tax (GST) -- which was intended to curb the use of multi-generational trusts to avoid estate taxation -- that appears to have spawned the interest in abolishing the rule.  Lifetime transfers of a certain amount of property are exempt from the GST (currently $5,000,000), and many Americans have created multi-generational trusts to take advantage of this exemption.  Apparently, many of those Americans see no reason why those trusts cannot last forever (or a really long time), and they have urged state legislators to abolish the rule.

John Carona, Author of SB 261According to a chart prepared by Elizabeth Schurig and Amy Jetel of the Austin firm of Schurig Jetel Beckett Tacket in 2007, at least 18 states have abolished the rule against perpetuities or extended it by many years, including Alaska (1,000 years), Arizona, Colorado (1,000 years), Delaware, Idaho, Illinois, Maine, Maryland, Missouri, New Hampshire, New Jersey, Rhode Island, South Dakota, Tennessee (260 years), Utah (1,000 years), Washington (150 years), Wisconsin and Wyoming.

A paper by Robert Sitkoff of Harvard Law School and Max Scanzenbach in 2008 lists 23 states as having "abolished" the RAP.  The Sitkoff/Scanzenbach paper used different criteria in adding Florida (360 years), Nebraska, North Carolina, Ohio, Pennsylvania and Virginia to the list and leaving Tennessee and Washington off the list.  The Sitkoff/Scanzenbach paper also gives some idea of the pace of adoption of anti-RAP legislation: 

  • Before 1985:  3 states
  • 1995-1999:  9 states
  • 2000-2004:  8 states
  • 2005-2007:  3 states

The paper was written in 2008, so it does not report legislative activity since 2007.

TBA believes Texas banks and trust companies are put at a competitive disadvantage because Texas still follows the rule.  Smaller banks and trust companies -- that have no out-of-state branches or affiliates -- are particularly hamstrung.  Wealthy Texans can create perpetual trusts now, but they must use an out-of-state bank or a big, national bank with offices in non-RAP states.  

Also, TBA believes the passage of the bill would simplify the rule by putting all trusts on equal footing with a simple term of years.  Further, the bill would end “RAP games,” where some attorneys incorporate the Kennedy or Royal families as the measuring lives.

The TBA has tried at least twice before to abolish the rule against perpetuities or extend the permissible duration of trusts.  In each case the legislation failed to pass.

Stephen Saunders, an Austin attorney, has opposed RAP repeal/modification legislation in the past and is opposed to  HB 372 and SB 261.  Mr. Saunders thinks that the RAP is good public policy -- and has been for 400 years.  He thinks modifying or repealing the RAP would have far-reaching consequences, including a reduction in charitable giving and increased litigation.  Also, he says, it would be bad social policy and tax policy.  Here is his 2003 paper giving reasons to leave the RAP alone.

The task of abolishing the RAP is more daunting in Texas because of the state constitution.  The Bill of Rights (Article 1, Section 26) provides:  "Perpetuities and monopolies are contrary to the genius of a free government, and shall never be allowed...."  It seems clear that the outright abolition of the rule against perpetuities would require a constitutional amendment.  Does substantially lengthening the permissible duration of trusts (in the typical case, 200 years is more than twice as long as the current limit) raise constitutional concerns?


Bill Pargaman's Legislative Preview

Bill PargamanBill Pargaman, Chair of the Legislative Committee of the Real Estate, Probate and Trust Law Section of the State Bar of Texas, has recently updated his preview of the upcoming Texas legislative session.

He discusses the legislative process, the impending codification of the Probate Code and the changes we can expect in probate, guardianship and trust law this year.



Session Begins January 11

The regular session of the 82nd Texas Legislature begins Tuesday, January 11, 2011.  The dominant issues this session promise to be the budget shortfall and redistricting.  Hopefully there will be some time given to other issues, like probate, guardianship and trust law legislation.

Sen. Chris Harris, the new chairman of the Jurisprudence CommitteeIn the Senate, Senator Chris Harris (R-Arlington) is the new chairman of the Jurisprudence Committee.  Most probate, guardianship and trust law legislation will go through the Jurisprudence Committee.  Other members of that committee are Senators Mario Gallegos, Jr. (D-Houston), John Carona (R-Dallas), Robert Duncan (R-Lubbock), Juan Hinojosa (D-McAllen), Joan Huffman (R-Southside Place) and Carlos Uresti (D-San Antonio).

The shape of the session in the House hasn't been determined.  At this writing (January 6, 2011), a speaker hasn't been chosen.  It is likely to take the new speaker weeks to make committee assignments.


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