SLAT – A Gift to a Trust with Spousal Access to the Funds
On November 16, 2017, Congress passed the Tax Cuts and Jobs Act of 2017 (the “Act”). This Act increased the unified credit amount from $5.49 million in 2017 to $11.18 million in 2018 (currently $11.58 million in 2020). In 2020, an individual can give up to $11.58 million away during his or her life and not have to pay any federal estate or gift tax on that amount. This increase is set to expire on December 31, 2025, at which point the unified credit amount will “sunset” back to the pre-2018 levels (indexed for inflation). This would bring the unified credit per person down to approximately $6 million.
Due to this known rollback of tax exemption, plus the potential for tax increases as the federal government needs to raise funds, now is a great time to reduce one’s estate by making gifts, directly to individuals or in trust for their benefit; especially since Congress has stated that individuals who take advantage of the current exemption while it is in place will still be able to maintain that advantage if the tax exemption sunsets. Once a gift is completed, the value of the asset is no longer included in the Donor’s estate, including any future appreciation attributed to that asset.
To that end, spousal lifetime access trusts (SLATs) have become a popular tax savings tool to utilize the benefit of lifetime gifts while maintaining some access to the funds.
What is a gift?
This may seem like a silly place to start, because everyone knows what constitutes a gift, but the technicalities of a gift from a legal perspective are important when dealing with gifts made to irrevocable trusts, especially a SLAT. The definition of a gift is simple, i.e. a voluntary, gratuitous transfer of property or interest in property made by one individual (the “Donor”) to a recipient (the “Donee”). However, there are three requirements that a transfer must have to be considered a gift: 1) delivery of the property, 2) donative intent by the Donor, and 3) acceptance by the Donee.
Donative intent and acceptance are important elements, but for a transfer to an irrevocable trust, delivery is the most crucial element when determining if a gift has been made, and therefore, the property has been removed from the Donor’s estate. At its basic level, delivery is just the transfer from the Donor to the Donee, but for the delivery to be complete, the Donor must relinquish control of the property. For instance, if the Donor transfers a vacation home to her children, but then lives in the home year round without paying rent and maintains all decisions about the maintenance and improvements regarding the home, the transfer will likely not be deemed a gift by the IRS. The home, plus any appreciation, will be included in the Donor’s estate for estate tax purposes.
It is important to remember with any gift that once the transfer is made, it is no longer the Donor’s property and he or she needs to relinquish control. In the context of a transfer to a trust, the more control the Donor maintains over the administration of the trust and the more access the Donor maintains over the trust property, the less likely the value of the trust will escape the Donor’s estate tax. This is particularly important for a SLAT, where by definition, some indirect access to the funds and some control over the administration of the trust is the goal.
What is a SLAT?
A SLAT is an irrevocable trust created by one spouse (the “donor spouse”) for the benefit of a group of beneficiaries that includes the other spouse (the “beneficiary spouse”). The trust is funded while both spouses are alive. The donor spouse will make a gift to the trust, which will use all or part of the donor spouse’s unified credit instead of the marital deduction.
Once the SLAT is funded, it operates similar to any other irrevocable trust. The trust will generally include provisions during the lifetime of the donor spouse and/or the beneficiary spouse, which allow the trustee to make income and principal distributions to a group of beneficiaries that includes the beneficiary spouse and family members. Upon the death of the survivor of the donor spouse and the beneficiary spouse, the trust property can then continue on for the other beneficiaries or be distributed outright to the beneficiaries without application of estate tax.
Why is a SLAT a good tax planning tool?
The use of a SLAT can be an effective tax planning tool for individuals who are concerned with paying federal and state estate tax upon the surviving spouse’s death. One benefit of creating a SLAT is that the funds in the trust and any increase in value will escape federal and state estate tax in both the donor spouse and the beneficiary spouse’s estates.
This trust can also provide some creditor protection for the donor spouse and the beneficiary spouse. If the trustee has complete discretion as to whether or not to provide income and principal to the beneficiary spouse, the funds will likely not be available to creditors. The donor spouse can also use the SLAT as a tool to allocate his or her generation-skipping transfer tax exemption to the trust funds.
Lastly, the main advantage of a SLAT versus any other irrevocable trust is that there is some level of access to the trust property for the donor spouse, via distributions to the beneficiary spouse, should a need for funds arise in the future.
What are the potential disadvantages/pitfalls of a SLAT?
While the use of a SLAT can be a good tax planning tool there are some disadvantages to this type of trust. The donor spouse must give up all control over the property placed in the trust, cannot be the trustee, and cannot request distributions from the trust. For example, if the trust allows distributions to the spouse and children, in the trustee’s discretion, the trustee could choose to only make distributions to the children, bypassing the spouse completely. The donor spouse also cannot change the beneficiaries or their interests after the creation of the trust.
SLATs will also likely be considered a “grantor trust” for income tax purposes, which means the donor spouse will be taxed on any income generated from the trust on his or her individual income tax returns, even though the donor spouse receives no benefit from the trust assets.
Finally, the trust funds will not be eligible to receive a “step-up” in basis upon the Donor’s death. As with any gift, assets transferred to the trust will maintain the Donor’s cost basis and capital gains tax will be applied when the trust assets are transferred or sold. The donor spouse should carefully consider the type of property they want to put into the trust prior to making such a transfer to make sure it complies with the family’s overall estate plan.
The primary pitfall for the creation of SLATs is known as the reciprocal trust doctrine.
Spouses may each want to create a SLAT for the benefit of the other spouse to take advantage of both spouses’ unified credits. The reciprocal trust doctrine states that the full value of a trust will be considered property of the donor’s estate when the donors create two interrelated trusts that leave the donors in the same economic situation they would have been had they created trusts naming themselves as life beneficiaries. In other words, if both spouses collectively have equal access to the funds after the transfer as they did prior to the transfer, the SLATs will be nullified.
If a couple wants to create two SLATs they must be careful to draft them in a manner which avoids violating the reciprocal trust doctrine. For example, the trusts could have different distribution terms and be created in different years. Careful consideration should be taken before choosing this option.
When choosing to create and fund a SLAT, the donor should consider what assets will be needed to support his or her lifestyle and make sure to not include those assets in the trust. Another, less pleasant, item to consider is the strength of the marriage. This type of trust is irrevocable and as such cannot be undone. If there is a divorce, the beneficiary spouse may have control over the property and it may be difficult to divide the assets.
If the donor spouse wants to give the beneficiary spouse a power of appointment, especially in a second marriage situation, it is important to consider who the beneficiary spouse will be allowed to appoint the property to in such a situation. If not drafted carefully, the beneficiary spouse could appoint the property to his or her children from a prior marriage or in the event of a divorce and remarriage, to a new spouse, which may not be the intent of the donor spouse.
While there are many advantages to creating and funding a SLAT, there are a few pitfalls. Contemplating the future needs of the family and potential for a breakdown of the family is important before creating this type of trust. A qualified estate planning attorney should be consulted to implement a wealth planning strategy that includes SLATs.
Pub. L. No. 115-97
Treas. Reg. §20.2010-1(c)
U.S. v. Grace’s Estate, 395 U.S. 316 (1969).
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