Since the introduction of a higher gift and estate lifetime exemption amount starting after 2017, the game of tax planning for most clients has changed from trying to reduce gift and estate tax to trying to reduce income taxes. For 2023, each taxpayer can pass $12.92 million to beneficiaries without having to pay gift and estate taxes. If you are married, this amount is $25.84 million. The top tax rate for estates is 40% exceeding these limits. Most taxpayers believe that with the gift and estate tax lifetime exemption so high, they do not need to worry about shrewd end of life tax planning. However, those high lifetime exemption amounts are scheduled to revert to pre-2017 amounts in 2026.
Due to this limited period of time with higher exemption amounts, many savvy taxpayers have turned to ways to use the higher exemption before it drops back down. That is why a Spousal Lifetime Access Trust or “SLAT” has become one of the most favored estate planning tools.
What is a SLAT?
A SLAT is an irrevocable trust where one spouse (donor spouse) gifts assets into a trust for the benefit of the other spouse (beneficiary spouse), while removing the assets from their combined estate. The beneficiary spouse may request distributions from the trustee of the trust, if needed, during their lifetime or allow the assets to compound without withdrawal. At the death of the beneficiary spouse, all assets, including appreciation, pass to the remainder beneficiaries (typically children) with no estate tax. No gift or estate tax is owed at the creation of the SLAT because the donor spouse elects to use their gift and estate tax lifetime exemption amount.
Benefits of a SLAT
The greatest benefit of a SLAT is that the assets are removed from a combined estate, but the beneficiary spouse may still request distributions from the trust, if needed. The donor spouse can still also benefit from those distributions as long as they are still married to the beneficiary spouse.
Because any post-gift appreciation will take place in the trust, it will also be excluded from the estate of both spouses. For example, a spouse could fund a SLAT for his wife with $12 million today, which she would have access to during her lifetime, and if value of the trust appreciated to $16 million by the time of her death, all $16 million would pass to their children estate tax free.
Spouses may also both create a SLAT for each other. However, there are very specific rules, and something called the ‘reciprocal trust doctrine’ that must be avoided in order to make two SLATs work in the eyes of the IRS.
SLATs are typically structured as grantor trusts for income tax purposes to allow the individual to pay income taxes on trust earnings from their personal income or assets rather than trust assets to preserve assets outside the estate.
Disadvantages of a SLAT
If the beneficiary spouse dies, the assets move to the remainder beneficiaries, typically the next generation, and are no longer accessible to the donor spouse. If the beneficiary spouse divorces the donor spouse, the donor spouse will also not be able to benefit from trust distributions. Divorce risk may be mitigated by terminating the beneficiary spouse’s interest in the event of divorce.
If two SLATs are created, careful planning must be done to avoid the ‘reciprocal trust doctrine’, which basically states that the two trusts were constructively similar. If the IRS deems the two SLATs are similar, then the trusts will be undone and includable inside the estate. Ways to mitigate this risk include creating trusts at different times, funding with different types of assets, providing different terms of distribution, or different beneficiaries, among other things.
Having a beneficiary spouse function as the trustee of the trust with too broad terms beyond the ascertainable standard of "health, education, maintenance, or support" could trigger the inclusion of the trust assets in the taxable estate. Spouses may consider whether an independent trustee or co-trustee should serve with a beneficiary spouse.
Any assets inside the trust will not receive the step-up in cost basis upon the death of the beneficiary spouse. The trust can include language that allows the power to swap or substitute assets of equal value with the trust, which would allow some flexibility in income tax planning during their lifetime.
Any assets placed into the trust must be owned by the donor spouse and not come from joint assets. However, SLATs can hold a variety of assets and may also own life insurance.
Summary
While tax changes are uncertain, a SLAT may be an effective wealth transfer strategy to consider while the estate tax exclusion remains at historically elevated levels and if the donor spouse has sufficient assets remaining outside of the SLAT to support their lifestyle. If you have questions on whether a SLAT is right for your family situation, we at Hollow Brook welcome the conversation. We have a vast network of estate attorneys who can review your current plan in detail and help you decide if a SLAT is right for you. As always, we want to make sure our clients have the right plan in place and the right team supporting their wealth transfer goals.
Disclaimer: Information provided is for educational purposes only. HBWM does not provide tax, legal, compliance, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. Further, HBWM makes no warranties with regard to such information, or a result obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.