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Spousal Lifetime Access Trust

Susan P. Rounds, JD, CPA, LL.M. (taxation), AEP®, TEP

Under the Tax Cuts and Jobs Act enacted in December 2017, the exemption amount against gift and estate taxes has doubled from the previous $5 million per person/$10 million per married couple to $10 million per person/$20 million per married couple. Indexed for inflation, the 2019 exemption has reached $11.4 million per person/ $22.8 million per married couple. The exemption amount applies to combined transfers made during life and at death.

This may be a significant opportunity for wealthy taxpayers, but will only last through the end of 2025. Under a sunset provision in the new law, the exemption will return to the previous amount of $5 million per person/$10 million per married couple, indexed for inflation, unless Congress extends the law. The change may affect a large number of current estate plans and create uncertainty around what decisions should be made to optimize the opportunity.

Transferring assets out of the estate now to reduce estate taxes later is often a good strategy, but taxpayers may be reluctant to make a large gift to take advantage of the increased exemption amount because they fear losing access to the transferred funds. Enter the Spousal Lifetime Access Trust (“SLAT”), a type of irrevocable trust that may be used to preserve the transfer tax benefit of the increased exemption amount while also building flexibility into the estate plan.

  • Structure: A SLAT is an irrevocable trust established by one spouse for the benefit of the other spouse and the couple’s children and/or grandchildren. It requires use of the donor spouse’s exemption amount to protect the transfer from gift tax.
  • Other Factors: Choosing an independent or corporate trustee is a best practice for asset protection purposes. The beneficiary-spouse can receive distributions in the discretion of the independent trustee, providing a safety-net.
  • Funding: When funding the SLAT, the grantor-spouse should use his or her separate property, as opposed to jointly owned or community property (this could make the transferred property includible in the estate of the beneficiary-spouse).

As an irrevocable grantor trust, the SLAT may provide some of the non-tax estate planning benefits listed below, while allowing the beneficiary-spouse access to the trust funds if needed.

  • Freeze Grantor’s Estate: The transfer to the SLAT is a completed gift and therefore removes future appreciation on the contributed assets from the estate of the grantor-spouse for purposes of estate and gift taxes (as well as generation-skipping transfer tax).
  • Additional Tax-Free Gifts: A SLAT is generally treated as a grantor trust for income tax purposes, meaningthat the grantor is responsible for paying the trust’s income taxes, and not the trust itself. This effectivelyallows the grantor to make additional tax-free gifts to the trust and its beneficiaries, thereby enhancing thewealth transfer benefits of the SLAT.

A few potential drawbacks to the SLAT are the following:

  • Access to Funds Is Not Unlimited: If distributions are made to the beneficiary-spouse, who consistentlyuses them to benefit the grantor-spouse, this could be considered a retained interest on the part of thegrantor-spouse and make the trust assets includible in the grantor-spouse’s estate for estate tax purposes.
  • Divorce or Death of Beneficiary-Spouse: If there is a divorce or the beneficiary-spouse dies, the grantor-spouse will lose indirect access to the trust. Accordingly, the grantor-spouse may want to limit the amounttransferred to the trust, or provide that if the grantor remarries, the new spouse will be a trust beneficiaryor that the trustee may lend trust property to the grantor.
  • Reciprocal Trust Doctrine: Couples may wish to establish SLATs for each other to ensure indirect accessto funds. To avoid the “Reciprocal Trust Doctrine,” which could effectively undo this planning, it isgenerally advisable to vary the provisions of the two trusts, such as by granting a power of appointment to only one spouse or by altering the distribution standards and classes of beneficiaries.

The SLAT is an important tool that may allow a grantor-spouse to take full advantage of the increased exemption amount while permitting indirect access to the trust funds by way of the beneficiary-spouse’s interest. Ideally, however, this access would never be needed, and as long as the grantor-spouse is still responsible for paying the trust’s income tax liability, an even greater amount of assets will pass to the next generation free of federal estate and gift tax.

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