The Importance of a Valid Disclaimer

Failure to execute a disclaimer can be a costly mistake.

hile estate planning normally occurs during life, it also can occur after a taxpayer’s death. In letter ruling (technical advice memorandum) 200437032, the IRS ruled that a bequest to a member of a religious order who had taken a vow of poverty did not qualify for the estate tax charitable deduction under IRC section 2055. CPAs should take note of this ruling—it illustrates how the failure to execute a disclaimer can be an expensive mistake.

The decedent’s sister, a member of a Roman Catholic religious order, had taken a perpetual vow of poverty that effectively turned over all of the assets she might thereafter own to the order.

The decedent’s will left his entire estate to his sister. Had she predeceased him, the order would have received the bequest. Instead, more than nine months after the decedent’s death, his sister transferred all of the assets to the order but did not execute a disclaimer. Had she done so, the assets would have passed directly to the order—as if the sister had never been bequeathed them—and qualified for an estate tax charitable deduction

The estate raised a number of arguments, as follows—all of which the IRS rejected:

The vow of poverty qualified as a disclaimer under IRC section 2518(a). The IRS said that, because the vow was not made in accordance with state law, it did not qualify as a disclaimer.

The vow and subsequent transfer of assets to the order constituted a valid disclaimer under section 2518(c)(3), which requires a written transfer and passing of the assets to the party that would have received them had a valid disclaimer been executed. The service again disagreed, citing case law, legislative history and its own rulings.

The vow terminated the sister’s interest in the legacy, under section 2055(a)’s “flush” language (that is, complete termination of a power to consume property before such power has been exercised shall be deemed a disclaimer). The IRS merely stated that the flush language did not apply in this case.

Thus, the estate was denied a charitable deduction for the assets passing to the order.

To ensure the transfer to the order would qualify for an estate tax deduction, the will should have provided a direct legacy. For example, if the decedent had wanted to provide for his sister if she left the order, the will could have stated: “In the event that my sister is no longer subject to a vow of poverty at my death, I give her my residuary estate. But if she is subject to such a vow, then I give my residuary estate to the order.”

Clearly, the sister should have been advised to execute a disclaimer. Because she did not, the order had to bear the entire estate tax on the bequest.

For more information, see the Tax Clinic, edited by Jerry Lerman, in the April 2005 issue of The Tax Adviser.

—Lesli S. Laffie, editor
The Tax Adviser

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