The federal estate, gift and generation-skipping tax is, once again, in flux. In late 2017, the existing exemption of $5.5 million per individual (roughly $11 million per married couple) was essentially doubled with the enactment of the Tax Cuts and Jobs Act. At present, each individual has a federal exemption amount of $11.7 million. With economic stimulus and proposed tax changes on the horizon, these exemption levels may not be available after 2021.
For some married clients, gifting to children and grandchildren by transferring assets to generation-skipping trusts for younger family members makes sense, particularly when there are ample assets in the couple’s portfolio to sufficiently provide for both spouses. However, for many clients, the prospect of gifting full exemption amounts, and giving up all income and other benefits afforded by those assets may prove to be too daunting or impractical. In these circumstances, a Spousal Lifetime Access Trust (“SLAT”) may be a sensible alternative.
A SLAT is in essence a gift from one spouse to a trust for the benefit of the other spouse during the beneficiary spouse’s lifetime. Unlike most traditional marital trusts, the SLAT becomes effective immediately upon transfer of assets, and the beneficiary spouse may receive distributions upon the trust’s inception (versus after the death of the donor spouse). In addition, a lifetime gift to a SLAT by a donor spouse is a completed gift for gift and estate tax purposes, and is not subject to an unlimited marital deduction (either because the terms of the trust prevent the gift from qualifying for the marital deduction, or because the donor spouse does not make the applicable election). This allows the donor spouse’s lifetime exemption to be applied to the gift.
The terms of a SLAT for the benefit of a spouse may be as flexible or inflexible as the donor spouse chooses, as it is not meant to qualify for a marital deduction in the donor spouse’s estate. For example, the terms of the trust may provide all income to the beneficiary spouse during his or her lifetime, or may allow an independent trustee to make distributions of income at his or her sole discretion. In addition, the beneficiary spouse is not required to be the primary or only beneficiary of the SLAT, and the terms of the SLAT may allow for additional beneficiaries to receive distributions during the beneficiary spouse’s lifetime.
For married couples who feel it prudent to take advantage of the increased exemption, but wish to maintain a level of beneficial enjoyment from their wealth (through an income or other beneficial interest), the SLAT may be a good solution, as the donor spouse can maintain an indirect beneficial interest through the beneficiary spouse during his or her lifetime. On the death of the donor spouse, the beneficiary spouse will retain the interest in the SLAT, and the assets gifted to the SLAT by the donor spouse will not be included in the value of the donor spouse’s estate. In addition, the donor spouse may, in appropriate circumstances, allocate a generation-skipping tax exemption to the gift to the SLAT to exempt the gift from tax for multiple generations. Transfers of assets to SLATs may provide the beneficiary spouse and other beneficiaries with an increased level of creditor protection, assuming the transfers into the SLAT are not done for the purpose of avoiding creditors.
In creating a SLAT, it is essential that the donor spouse not serve as a trustee, or distributions to a beneficiary spouse who is also serving as a trustee be limited by an ascertainable standard. Therefore, it is advisable to have an independent trustee serve as a trustee, especially if the SLAT has multiple beneficiaries. In addition, it is also important to keep in mind that a SLAT is an irrevocable trust, and transfers into a SLAT are completed gifts which cannot be reclaimed by the donor spouse. Therefore, on the death of the beneficiary spouse, the assets in the SLAT will pass to the remainder beneficiaries, and will not, under most circumstances revert back to the donor spouse. In addition, if the donor spouse and the beneficiary spouse should divorce after the SLAT is created, the donor spouse will no longer have indirect access to trust assets as a beneficiary. If the SLAT is considered a grantor trust, the donor spouse will continue to pay the income taxes on the trust income after the divorce. If the SLAT is a grantor trust and the donor retains a substitution power, the donor may be able to substitute cash for assets which have appreciated after contribution to trust and obtain a step-up in basis upon the donor’s death.
Many couples, in order to maximize the benefits of using their lifetime gift tax exemptions through the use of the SLAT, will create two SLATS, with each spouse creating once to benefit the other. This would allow for each spouse to fund a SLAT with the balance of his or her remaining lifetime exemption. When this happens, it is important to create trusts that are not identical to each other to avoid the IRS from invoking the reciprocal trust doctrine, which would include the value of each trust created for the other spouse to be included in the donor spouse’s estate. This can be accomplished by creating different dispositive provisions with respect to the beneficiary spouses (i.e. one spouse could receive all of the income, while the other receives discretionary distributions), or providing the beneficiary spouses with differing powers of appointment.
Other important considerations in funding a SLAT are the differences between the federal and state tax gift tax exemptions. This is particularly relevant to residents of Connecticut. In 2021, Connecticut has a lifetime gift and estate tax exemption of $7.1 million. While current law provides a gradual increase in the exemption over the next few years, couples should be mindful that fully funding SLATs to take advantage of the remaining federal lifetime gift tax exemption may result in a significant state gift tax. In addition, lifetime gifts are subject to carryover basis rules for income tax purposes, and assets transferred to a SLAT will not be afforded a step-up in basis on the death of the donor spouse.
In conclusion, while a SLAT can be a flexible arrangement for married couples to utilize the lifetime exemption while allowing the donor spouse to retain indirect access to the beneficial interests of the assets transferred to the SLAT, there are many issues to consider. We encourage you to consult with one of our attorneys on this matter in the course of your planning to determine whether a SLAT is an appropriate addition to your current plan.