Are Spousal Lifetime Access Trusts the Right Fit for You?

Harris Beach PLLC
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Spousal Lifetime Access Trusts, or “SLATs,” may be the ideal vehicle for clients interested in pursuing wealth-transfer tax planning.

A SLAT is an irrevocable trust created by one spouse for the primary benefit of the other spouse and, to the extent desired, the descendants of either or both spouses.  The donor-spouse makes a completed gift to the SLAT but maintains continued access to the transferred assets indirectly through the beneficiary-spouse’s beneficial interest in the SLAT.  The powers retained by the donor-spouse and the beneficial interest of the beneficiary-spouse are tailored so that the assets of the SLAT are not included in either spouse’s estate for estate tax purposes.

But before deciding whether SLATs may be the right fit, it’s important to review certain fundamentals of the wealth transfer tax system.

Background

The federal wealth transfer tax system consists of three different taxes: 1) estate tax; 2) gift tax; and 3) generation-skipping transfer tax.  The centerpiece of the federal wealth transfer tax system is the “basic exclusion amount” (commonly referred to as the “exemption”) which exempts assets up to a certain value from the imposition of gift or estate tax. 

Taxable gifts made during an individual’s lifetime use up a donor’s the basic exclusion amount. Any basic exclusion amount remaining upon the individual’s death is converted into a credit and applied against the estate tax imposed on the decedent’s taxable estate.  To the extent any amount of the applicable credit remains unused after reducing the federal estate tax to zero, such amount is converted back to the basic exclusion amount and is portable and can be “acquired” by the surviving spouse for the surviving spouse’s use during lifetime or at death.

Making substantial gifts now may be beneficial from a wealth transfer tax planning perspective especially considering current federal tax law which provides each individual with $12,060,000 of basic exclusion amount in 2022.  However, the basic exclusion amount will “sunset” back to its 2017 level (approximately $6,000,000) beginning January 1, 2026. In other words, about $6,000,000 of tax exemption will be lost if unused prior to 2026!  SLATs are a way to use the basic exclusion amount now without the donor-spouse relinquishing indirect access to the assets contributed to the SLAT.  Many donors may be understandably reluctant to make large gifts directly to a spouse, children, and grandchildren.  Outright transfers result in the immediate relinquishment of control by a donor to the recipient.  Once controlled by the recipient, the assets are subject to the spending habits and lifestyle choices of the recipient and the assets may be accessible to the recipient’s creditors including a spouse in the context of divorce.

Advantages of SLATs

  • Transferring assets to a trust, specifically a SLAT, not only allows the donor to dictate the terms governing the transferred assets, it also allows the donor to protect the assets from the potential creditors of the beneficiaries and from the beneficiaries themselves.  Uniquely, a SLAT provides continued access to the transferred assets to the donor’s spouse such that assets remain within the reach of the marital unit and can be accessed if needed in the future.
  • The transfer to a SLAT is a taxable gift that uses the donor-spouse’s basic exclusion amount and removes the assets (and the appreciation on the assets) from the federal taxable estate of the donor-spouse and, provided the transfer occurs more than three years prior to death, from the donor-spouse’s New York state gross estate.  If the donor-spouse desires to benefit grandchildren and future generations, the GST exemption can be applied to accomplish this goal as well making the SLAT a dynasty-type trust.
  • Planning with SLATs can be done by each spouse for the primary benefit of the other spouse thereby providing each spouse with continued access to the assets of the SLAT created for his or her respective benefit.

Considerations for SLATs

  • Lifetime gifting to a SLAT is complex and not without drawbacks.  For example, where both spouses make transfers to SLATs, the trust agreements must be sufficiently different and should occur at different times so the Internal Revenue Service does not unwind the transactions under the “Reciprocal Trust Doctrine” thereby eliminating the beneficial tax planning. 
  • From a tax perspective, since assets transferred to the SLAT will not be includible in the donor-spouse’s estate for estate tax purposes, the assets transferred to the SLAT will similarly not receive an income tax basis adjustment (a “step-up”) upon the death of the donor-spouse.
  • The trust agreement will provide an independent trustee with the ability to cause SLAT assets to be included in the gross estate of the beneficiary-spouse if it is desirable, because it will reduce overall taxes to do so. 
  • Issues of continued control and governance arise in the context of transferring closely-held business interests to a SLAT, as with any irrevocable trust.  Reorganizing or recapitalizing the closely-held business to change the voting structure may be necessary. 
  • The donor-spouse’s indirect access to the SLAT via the beneficiary-spouse’s interest ceases to exist upon the beneficiary-spouse’s death or if the spouses divorce. 
  • In most cases, a valuation report prepared by a valuation expert will be required, and in all cases, a gift tax return will be required to be filed.

Bottom line:

The decision to pursue SLATs as a vehicle for transferring wealth depends on various considerations. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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