The Tax Cuts and Jobs Act of 2017 (TCJA) doubled the federal gift and estate tax basic exclusion amount (referred to here as “exemption”) from $5 million to $10 million (adjusted for inflation). In 2022, the federal gift and estate tax exemption is $12.06 million, which generally means that an individual can transfer $12.06 million of assets before having to pay a gift or estate tax (at a maximum rate of 40%). Unless new legislation is passed, this exemption will reset to $5 million (adjusted for inflation) on January 1, 2026.
In light of the 2026 sunset and clients’ tendency to review their gifting plans at year-end, estate planning attorneys may consider introducing certain measures to help their clients make use of the increased exemption amount before it decreases. One such measure is 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) and other beneficiaries such as children or grandchildren. The transfer to the trust is intentionally designed not to qualify for the unlimited marital deduction so that the donor spouse’s estate tax exemption can be utilized to the fullest possible extent, 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) is appointed to make discretionary distributions from the trust for any purpose. If the beneficiary spouse or any other beneficiary of the trust is 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: a beneficiary’s creditors may be able to reach income or principal to which a debtor beneficiary is entitled.
2. The Definition of “Spouse”
The ideal SLAT clients 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 that covers divorce and remarriage when creating a SLAT, which means defining the term “spouse” as the person to whom the grantor is currently married (also known as a floating spouse provision). This provision also means the grantor may regain access to the trust if the grantor later remarries.
3. Funding with Joint Property
The ideal SLAT grantor individually owns the assets to be transferred to the SLAT, but in reality, married grantors often own property jointly with their spouse. An asset held jointly with rights of survivorship or as a tenancy by the entirety must be divided 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 transfer to the SLAT in order to maximize the donor spouse’s exemption amount. The key is to allow time to pass between the beneficiary spouse’s transfer of property to the donor spouse and the donor spouse’s contribution of that property to the SLAT. Otherwise, the Internal Revenue Service (IRS) may apply the step transaction doctrine, which denies the tax benefits derived from a series of transactions that should really be treated as one. If applied, the beneficiary spouse may be deemed to have contributed assets to the SLAT directly, causing some or all of the value of the assets to be included in the beneficiary spouse’s gross estate for estate tax purposes.
4. Funding 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 (and therefore no guarantee of indirect, backdoor access for the donor spouse). Attorneys counseling clients on this strategy should encourage them to involve their financial advisors to balance their standard of living and 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. Ask financial advisors to illustrate the results of various SLAT funding scenarios before embarking on the transfers described above.
5. Planning 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 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 nonspouse beneficiaries and powers of appointment.
Educate your clients on this approach now to give them ample time to incorporate it into their estate plans, if appropriate. Your assistance with valuable wealth preservation strategies can benefit multiple generations of clients.
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