For married couples looking to use their lifetime gift exemptions and protect their assets, spousal lifetime access trusts (SLATs) are an attractive option.
A SLAT is an irrevocable trust created by one spouse for the benefit of the other. The spouse who creates the trust (the “donor spouse”) makes a gift to the trust, using some or all of his or her lifetime gift exemption, and names his or her spouse (the “beneficiary spouse”) as an initial trust beneficiary. Other beneficiaries can include the couple’s children or more remote descendants. These beneficiaries can be named as initial beneficiaries with the beneficiary spouse or as remainder beneficiaries. The appropriate structure will depend on each family’s goals and circumstances.
SLATs offer flexibility not available with most other gifting strategies. Most notably, while the couple is married and both spouses are living, SLATs allow the donor spouse to essentially have indirect access to the gifted assets through the beneficiary spouse. Even for very wealthy couples, this added flexibility is comforting. It helps to alleviate one of the most significant concerns of those contemplating substantial gifts, and that is the fear of one day having to ask your beneficiary for money.
SLATs have other benefits as well. SLAT assets are excluded from both spouses’ estates. And because SLATs are generally grantor trusts for federal income tax purposes (meaning the donor spouse and not the trust pays the income taxes), the trust’s assets can compound unabated by taxes, and the donor spouse can sell appreciated assets to the SLAT without realizing gain.
Despite the many benefits and flexibility offered by SLATs, there are a few things that clients should consider.
First, clients should consider the potential income tax liability flowing from the SLAT to the donor spouse not only in the present, but also in the future. Most often, clients are aware of the current and short-term performance prospects of their businesses and/or investments and the potential income tax obligations associated with those assets; however, clients may not be as familiar with the longer-term prospects. If the donor spouse gifts a business to a SLAT, for instance, and that business experiences significant long-term growth, the donor spouse would potentially be responsible for the taxes associated with that growth. Without proper planning and direct access to the income of the business, which flows to the SLAT, this responsibility could strain the donor spouse’s personal finances. Similarly, if the goal is to sell the assets gifted to the SLAT and reinvest in other assets, clients should consider the mix of those investments and the extent they might produce income.
Second, clients should consider the consequences of divorce. Of course, clients considering divorce do not create SLATs, and when a marriage is good, divorce is the last thing on a couple’s mind. Nevertheless, clients should not turn a blind eye to the possibility of divorce because, as it does in other aspects of a person’s life, divorce can have real negative impacts on SLAT planning. For example, divorce would cut off the donor spouse’s indirect access but still potentially leave him or her responsible for paying income taxes on the trust.
Lastly, couples looking to create two SLATs — one for each spouse — should be careful to make the trusts different enough so that they do not fall victim to the IRS’s reciprocal trust doctrine. Under this doctrine, the IRS can seek to include the trusts back into each spouse’s estate, defeating the tax planning purpose of SLATs.
Each of these risks can be mitigated by a professional experienced with SLAT planning.
Earlier this year, proposals were floated in Congress that would change grantor trust taxation and lower the estate tax exemption. Neither proposal moved beyond that at this point. Regardless, time is running out on the current estate tax exemption amount. In 2021, the exemption is $11.7 million for individuals and will continue to increase annually based on inflation until Jan. 1, 2026, when it is scheduled to sunset, reverting back to the 2011 level of $5 million (indexed for inflation).
Planning to use the exemption now instead of waiting until 2025 allows time for more thoughtful preparation, and a properly executed estate plan means less likelihood of IRS scrutiny.
For more information about spousal lifetime access trusts, contact our team.