The Spousal Lifetime Access Trust - Almost Too Good to Be True
THE COUNSELOR
Volume 11 • Issue 4 • April 2021
The Counselor is a newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue will discuss a popular wealth transfer and asset protection strategy known as a Spousal Lifetime Access Trust. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Senators Bernie Sanders and Sheldon Whitehouse recently introduced the “FOR THE 99.5 PERCENT ACT” which could dramatically reduce the federal estate tax and gift tax exemptions. According to the proposed Act, the estate tax exemption amount would be reduced from the current $11.7M per person to just $3.5M. The lifetime gift tax exemption would also be reduced from the existing $11.7M per person amount to $1M per person. If passed, this Act will become effective on December 31, 2021. However, even if the Act does not pass, the exemption amounts are scheduled to be reduced by 50% beginning on January 1, 2026. All of this means serious consideration should be given to using your existing exemption before it disappears. One popular tool for doing this, that in some ways is almost too good to be true, is the Spousal Lifetime Access Trust or SLAT.
A SLAT is an irrevocable trust that is created by one spouse (the Grantor Spouse) for the benefit of the other spouse (the Beneficiary Spouse) during his/her lifetime. Upon the death of the spouse, the remaining trust proceeds are held or distributed pursuant to the terms of the SLAT. Because the trust is for the benefit of the spouse, that spouse can receive distributions from the SLAT allowing the couple to still have “access” to the benefits of the assets held by the SLAT.
What Are the Benefits of a SLAT?
What are the benefits of a SLAT? Here are several:
The couple can move significant assets into SLATs yet continue to access all of those assets.
The Beneficiary Spouse can serve as Trustee, though it is recommended that the Trustee be an independent Trustee for maximum estate tax benefits and asset protection.
The Grantor Spouse can reserve the right to change the Trustee.
Meaningful asset protection from potential claims of creditors assuming assets transferred to the trust are not characterized as a fraudulent conveyance.
Because SLATs are not “self-settled trusts” (trusts that benefit the Grantor) and benefit a third-party, the Beneficiary Spouse, they should not be subject to the risks inherent in traditional Domestic Asset Protection Trusts for individuals residing in jurisdictions that do not permit them.
The SLAT can be drafted so that the value of the assets are still included in the Grantor Spouse’s estate for estate tax purposes and receive a step-up in income tax basis or so that the value of the assets are outside of the Grantor Spouse’s estate for estate tax purposes.
Even if drafted so that assets do not receive a step-up in income tax basis at your death, it can be drafted so that assets can be swapped moving highly appreciated assets back into the Grantor Spouse’s personal name in exchange for other assets if the circumstances warrant.
If taxed as a grantor trust for income tax purposes, meaning the Grantor Spouse bears the income tax burden on trust earnings, assets effectively grow tax-free, thereby enhancing the estate tax and asset protection benefits.
SLATs can function as life insurance trusts (ILITs) and be used to protect and manage life insurance proceeds in a more robust way because they hold other assets. Income earned on other assets can be used to pay annual policy premiums and avoid the need for annual cash gifts.
What is the Downside to a SLAT?
As you can see, so much about the SLAT seems almost too good to be true. There must be a catch. There are a few areas of concern. One problem can arise in the event of a divorce from the Beneficiary Spouse or the premature death of the Beneficiary Spouse. Access by the Grantor Spouse to the SLAT assets are premised on the Beneficiary Spouse’s access. The concern with divorce can be mitigated somewhat by using a “rolling” spouse. This means that instead of naming a specific person as your “spouse” that term is defined as whomever is your “spouse” at that point in time. However, if there is no spouse because of death or divorce, the Grantor Spouse must then rely on the remainder beneficiaries, such as children, to provide access to the assets.
Another area of concern is what is known as the “Reciprocal Trust Doctrine.” The Reciprocal Trust Doctrine states that if Spouse 1 creates a trust for Spouse 2, and Spouse 2 creates a nearly identical trust for Spouse 1, then the two trusts may be “un-crossed” and treated for tax purposes as if each spouse had created a trust for his/her own self. This will result in the assets still being part of the Grantor Spouse’s estate for estate tax purposes. The Reciprocal Trust Doctrine is relatively easy to avoid by making sure there are sufficient differences between the two trusts.
As you can see, irrevocable trusts, such as SLATs, serve a multitude of significant estate planning and asset protection objectives. To effectuate these goals, proper creation and administration of the trust is required. You should always be aware that the Internal Revenue Service may review the implementation and administration procedures of your trust. Questionable practices could result in expensive audits and litigation, as well as potentially significant adverse gift, estate, and income tax consequences. Accordingly, it is critical that you receive quality professional advice when considering the use of a SLAT or other irrevocable trust as part of your estate or asset protection plan. But when correctly created and implemented, the SLAT is an amazing way that many people are using to minimize estate tax exposure and obtain asset protection.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.