The Tax Cuts and Jobs Act of 2017 doubled the federal gift and estate tax applicable exclusion amount from $5 million to $10 million, adjusted for inflation. In 2021, the federal gift and estate tax exemption is set at $11.7 million, which generally means that an individual can transfer $11.7 million worth of assets before having to pay any gift or estate tax on the transfer (at a maximum rate of 40%). However, on January 1, 2026, unless new legislation is passed by Congress, the transfer tax exemption will automatically reset to $5 million, adjusted for inflation.
In view of the 2026 sunset for the high exemption, savvy clients are reviewing their gifting plans now, using techniques to ensure that they take full advantage of the high exemption amount before it decreases. One such technique is known as a Spousal Lifetime Access Trust (“SLAT”). This strategy allows a donor spouse to make a gift of property to an irrevocable trust for the benefit of the other spouse, as a beneficiary of the trust, as well as to other beneficiaries such as children and grandchildren. The transfer to the trust is intentionally designed NOT to qualify for the unlimited marital deduction. This is so that the donor spouse's estate tax exemption may be utilized to the fullest extent possible and the appreciation on the assets transferred to the SLAT will not be subject to future gift and estate tax.
- 1. Choosing the Right Trustee
The choice of trustee is crucial when creating a SLAT. The donor spouse should not serve as trustee. Ideally, an independent trustee (someone who does not have an interest in the trust) should be appointed to make discretionary distributions from the trust for any purpose. If the beneficiary-spouse or any other beneficiary of the trust serves as trustee, distributions should either be mandatory or subject to an ascertainable standard, such as restricting distributions to providing for a beneficiary's health, education, maintenance or support. Keep in mind that the distribution standard affects the trust's level of creditor protection; that is to say, a beneficiary's creditors may be able to reach income or principal to which a debtor beneficiary is entitled.
- 2. Definition of “Spouse”
The ideal clients for a SLAT are happily married and own property expected to significantly appreciate that they can irrevocably transfer while still maintaining their standard of living. Nevertheless, one advantage of the SLAT is that its income and principal can be distributed to the beneficiary spouse, allowing indirect, backdoor access to the donor spouse. This door closes, however, if the beneficiary spouse predeceases the donor spouse or if the couple divorces. In the event of divorce, the beneficiary spouse should not continue to benefit, especially when the donor spouse is paying the trust's income tax. Though uncomfortable, clients should consider including language which covers divorce and remarriage when creating a SLAT. Specifically, this involves defining the term “spouse” as the person to whom the grantor is currently married (commonly known as a “floating spouse” provision). This provision also means that the grantor may regain access to the trust corpus if the grantor later remarries.
- 3. Funding with Joint Property
Although the ideal grantor of a SLAT individually owns the assets to be transferred to the SLAT, as his or her sole and separate property, in reality, married grantors typically own property jointly with their spouse or as their community property. An asset held jointly with right of survivorship or as community property must be divided first into individual shares or transferred entirely to the donor spouse before being transferred by the donor spouse to the SLAT. Transfers between US-citizen spouses are not subject to gift tax, so the beneficiary spouse can freely give property to the donor spouse to then transfer to the SLAT in order to maximize the donor spouse's exemption amount. The key is to allow time to pass between (1) the beneficiary spouse's transfer of property to the donor spouse and (2) the donor spouse's contribution of the property to the SLAT. Otherwise, the Internal Revenue Service may apply the “step transaction” doctrine, which denies the tax benefits derived from a series of transactions that really should be treated as a single transaction. If applied, the beneficiary spouse may be deemed to have contributed assets to the SLAT directly, causing some or all of the assets' value to be included in the beneficiary spouse's gross estate for federal estate tax purposes.
- 4. Funding a SLAT out of Fear
Absent mandatory distributions or withdrawal rights, there is no guarantee that a beneficiary spouse will actually receive a distribution from the SLAT. Thus, there is no guarantee of indirect, backdoor access for the donor spouse. Attorneys who counsel clients on this strategy should encourage them to involve their financial advisors to balance their standard of living against their desire to maximize the donor spouse's tax exemption. In other words, couples should not fund SLATs out of fear of losing the transfer tax exemption and risk reducing their wealth below what they need to be comfortable for their remaining lifetimes.
- 5. Using More Than One SLAT
Taking into account the planning concerns associated with divorce and avoiding step transactions, couples may wish to create two SLATs so that each spouse can fund their own trust using their own assets. If so, attorneys need to be aware of and help them avoid another stumbling block: the IRS's “reciprocal trust” doctrine. This doctrine is applied when trusts are interrelated and, taken together, create an arrangement of mutual value that leaves the grantors in approximately the same economic position as they would have been in had each created a trust naming themselves as life beneficiaries. If applied, the trusts are essentially uncrossed so that the beneficiary spouse is treated as the grantor of the donor spouse's trust, and the trust assets are included in the beneficiary spouse's gross estate for estate tax purposes. The key, here, is to avoid creating SLATs with substantially similar provisions. The most obvious approach is to create different types of trusts altogether: for example, one spouse may create a SLAT while the other creates an irrevocable life insurance trust (ILIT) or an intentionally defective grantor trust (IDGT). But if two SLATs are desired, apply different distribution options: one trust might grant a withdrawal power to the beneficiary spouse while the other does not, or principal distributions from one trust might be subject to an ascertainable standard while the other is wholly discretionary. Another way to distinguish SLATs is with different classes of non-spouse beneficiaries and powers of appointment.
For more information on using a SLAT to reduce federal gift and estate tax, please contact the Law Offices of Keith Codron at (949) 622-5450, or email Mr. Codron at [email protected]