Here we are on the eve of another important election and among the issues that people worry about is, as always, what will it mean for tax policy? With historically high lifetime estate and gift tax exemptions ($12.06 million in 2022, scheduled to increase to $12.92 million in 2023) there is concern that new Congressional action might reduce this level significantly. Even without action by Congress, the exemptions that exist now are set to revert after 2025 to pre-2018 levels (approximately $6.9 million). One way or another, with the exclusion at risk of being reduced, individuals should consider taking advantage of gifting strategies now. One such method is the Spousal Lifetime Access Trust or “SLAT”.
In the case of the SLAT, the primary goal is to remove assets from a person’s taxable estate, and his or her spouse’s, without completely relinquishing access to those assets in the event of unexpected need. The reason this strategy is so valuable during this window is that it allows the permanent shielding of a larger gift amount while the exemption is high, even though the exemption might be reduced later.
Here are the typical features:
- As you might expect by the name, the strategy requires that taxpayer making the gift be married
- The trust is irrevocable, and the grantor must forever part with the income from, or direct access to, the assets. Access to the trust assets by the beneficiary spouse potentially provides access to the donor spouse in an emergency.
- The trust is funded with the separate assets of the donor spouse and is established for the benefit of the non-funding spouse and descendants. The beneficiary spouse generally has the right to distribute assets to him/herself according to something called an ascertainable standard (health, education, maintenance and support). In a perfect world, the assets in the trust are ultimately to be used not by the beneficiary spouse, but to survive for the benefit of future generations.
- The trust is drafted in such a way as to prevent inclusion in the estate of the beneficiary spouse, thus benefitting both spouses.
- The trust is normally established as a “dynasty” trust, meaning it may continue in perpetuity for the benefit of future generations without being includible in the estate of any particular future generation.
- The income tax on trust income falls to the grantor of the trust rather than the trust itself. This is good from the standpoint that the grantor is passing additional value to the next generation free of estate tax by unburdening the trust income from income tax
What’s not to like, then? There are plenty of cautionary notes to consider before one decides this is a strategy that is appropriate. First, the formalities of the trust must be observed. Failures to abide by the terms of the trust can easily unravel the entire scheme and create estate tax inclusion when it was not intended. It is also important to take into consideration who might be an independent trustee to make decisions about distributions to the beneficiaries beyond those limited by the ascertainable standard and the grantor must be willing and able to pay the income tax on trust income. The donor must contribute only individually owned assets, so if spouses only own assets jointly, those tenancies must be severed to create ownership by each separate tenant. If the ownership of combined assets is skewed to one spouse or the other, gifts between spouses may be required prior to funding the trust.
SLATs create other benefits and may work in unison with other tax and estate planning strategies. They can create creditor protection by containing “spendthrift” provisions and avoid probate. They can be used in conjunction with discounts on gifted assets or as beneficiaries of other types of trusts, like grantor retained income trusts. They are relatively easy to establish and maintain (no income tax return for the trust) compared some other estate tax strategies.
As with any gift as a strategy to reduce estate tax, one downside is that the assets in the trust don’t receive a step up in basis at the death of the donor. If assets are sold by the trust while the donor is still alive, the donor will pay any tax on the contributed gain. However, once the donor dies, the trust pays the tax on that pre-death gain. The problem may be mitigated by a provision in the trust that allows the donor to replace low basis assets with high basis assets (like cash) of equal value prior to death, but the donor must have such assets available.
In the end, SLATs can have tremendous applicability and utility but should not be undertaken without due consideration of the donor/spouse’s circumstances and risk tolerances. That said, if this is something you believe is a strategy for you, do not wait too long to investigate it. Time is of the essence, given the ever-present possibility for change.
Should you have any questions, please feel free to contact Snyder Cohn.
By Tim Moore