Q: Can disclaiming inheritance from a Trust be used as a method of tax avoidance between beneficiaries of that trust?
Person A and B are tenants in common in a property that is valued at $1,000,000 and has a basis of $200,000.
Their mother dies leaving them $2,000,000 in a trust to be distributed equally.
Person A disclaims $500,000 of his inheritance from the trust.
Person B signs a quitclaim deed transferring all ownership in the shared property to A.
The result is Person A fully owns the property and received $500,000 from the trust; Person B received $1,500,000 from the trust.
Presuming all totals are under various federal and state gifting/inheritance/estate tax limits is this a completely tax-free situation?
My initial thought is this approach is ok and tax free. Disclaiming a portion of the inheritance is not viewed as a gift, payment, or any other consideration from A to B since A did not have control of how the disclaimed funds would be distributed. Then the quitclaim transfer would be viewed as a gift since there was no consideration in exchange for it.
A: A gift tax return should be filed by Person B for the gift of their interest in the property to person A, but at person B's option, no estimated gift tax need be paid at this time, since the amount will be added back into Person B's gross estate when Person B dies for purposes of determining whether B's estate is subject to the federal estate and gift tax or whether the gross estate that includes the gift amount is still below the then-existing federal estate tax exemption. There is no tax event upon distribution of the funds from the trust. The disclaimer does not cause a tax event. However, Person A gets the short end of the deal tax-wise in this scenario. The reason is, Person A receives the same tax basis in the property as Person B had, so Person A now owns a $1,000,000 asset with a tax basis of $200,000, leaving $800,000 subject to capital gains tax upon sale. Person B traded $500,000 --of which 80% is subject to taxable capital gains-- for $500,000 in nontaxable inheritance, thereby avoiding having to pay capital gains tax on the $400,000 had the property been sold while he was still an owner. Conversely, Person A traded non-taxable inheritance of $500,000 for a $500,000 interest in real property of which $400,000 will be subject to capital gains tax if and when she sells the property. If Person A never sells the property, but leaves it to her heirs after she dies, then the tax basis in the property is raised to the FMV of the property at he time of her death, which will eliminate any taxable gains tax paid by her estate or heirs on the property. So, unless Person A keeps the property until she dies, Person A will pay Person B's capital gains tax and get nothing in return for it. Good for Person B, not so good for Person A. You may want to run this past a tax accountant if you need further clarification or confirmation.
Steven J. Fromm agrees with this answer
A: I caveat my answer with the fact that I am not a tax lawyer even if I got an A in Tax Law at Georgetown. That's why I employ a Georgetown LlM in tax to help my clients. But, off-hand, I think the real estate transfer is taxable based on the assessed value of the property. I think the exclusion is for gift transfers to an entity such as a living trust or LLC owned by the same person in title. I would want the Code in my hand and an opinion letter in my file before doing this. Further, I think the disclaimed funds are subject to a much smaller inheritance tax in Maryland. I believe the disclaimed grant from the trust to the sibling might be a lineal 1% tax, rather than a collateral 10% tax when coming as a distribution from the trust, but, again ... Code... opinion letter. Further, I'd be cautious about tax fraud here, since there is actual consideration for the simultaneous exchange of disclaimer for real estate. All in all, an opinion from a tax lawyer is a brilliant idea here.
A: Attorney Oakley cover the gift tax implications expertly. However, if you do a disclaimer, it is as if you died and the assets goes to your children and not to a non-related party. Your disclaimer may not work here as you plan.
Additionally, if A and B are not related, you may be entering into a "disguised sale" and the IRS has the power to impose a doctrine called "substance over form" to overturn this transaction and impose income taxes on the disguised sales. You really need to meet with a tax/estate attorney to lay out the facts to allow this strategy to be researched to see if it actually works. Otherwise, it may blow up in your face later and you will not be able to undo these transactions and transfers.
Justia Ask a Lawyer is a forum for consumers to get answers to basic legal questions. Any information sent through Justia Ask a Lawyer is not secure and is done so on a non-confidential basis only.
The use of this website to ask questions or receive answers does not create an attorney–client relationship between you and Justia, or between you and any attorney who receives your information or responds to your questions, nor is it intended to create such a relationship. Additionally, no responses on this forum constitute legal advice, which must be tailored to the specific circumstances of each case. You should not act upon information provided in Justia Ask a Lawyer without seeking professional counsel from an attorney admitted or authorized to practice in your jurisdiction. Justia assumes no responsibility to any person who relies on information contained on or received through this site and disclaims all liability in respect to such information.
Justia cannot guarantee that the information on this website (including any legal information provided by an attorney through this service) is accurate, complete, or up-to-date. While we intend to make every attempt to keep the information on this site current, the owners of and contributors to this site make no claims, promises or guarantees about the accuracy, completeness or adequacy of the information contained in or linked to from this site.