Spousal Lifetime Access Trusts Basics

Spousal Lifetime Access Trusts (“SLATs”) are one of the many estate planning tools available to taxpayers, and have seen a surge in popularity recently, such that they are one of the most used options for utilizing taxpayers’ federal lifetime gift and estate tax exclusion (“Exclusion”) during life. Each taxpayer’s Exclusion amount, or the amount which they can pass to another during their life or at death without being subject to the federal gift or estate tax, is currently set at $12.06 million.[1] However, the Exclusion amount is scheduled to sunset back to $5 million (subject to adjustment for inflation) on January 1, 2026[2] along side many other individual taxpayer provisions enacted by the Tax Cuts and Jobs Act of 2017 which are expiring. Couple the scheduled sunset with the constant uncertainty surrounding potential tax reform that has accompanied the Biden administration, including the prospect of retroactive tax legislation, it is no wonder that taxpayers are trying to use their Exclusion now.

In this article, we will cover some of the basics for SLATs. In a future article we will discuss some more complicated planning strategies, potential issues, and other situations that involving SLATs.

Basics and Advantages

SLATs are irrevocable trusts, generally established for the benefit of the grantor’s spouse (and potentially other individuals such as descendants) during such spouse’s lifetime. Typically, the couple’s descendants would be named as remainder beneficiaries after the death of the beneficiary spouse. Often, the beneficiary spouse would be named as trustee of the SLAT established for his or her benefit, although many practitioners believe that doing so is not considered best practice. This is because the beneficiary spouse would be limited to making distributions for their own health, education, maintenance, and support and are less likely than an independent trustee to document compliance with such. Additionally, the beneficiary spouse may be prone to act at the bidding of the grantor spouse. Either event gives the IRS an opening to challenge and potentially unravel the estate and gift tax planning benefits of the SLAT.

The assets transferred to the SLAT by the grantor are generally no longer included in the taxable estate of the grantor or the grantor’s spouse, typically by utilizing the grantor’s Exclusion such that no gift tax is paid on the transfer and no estate tax is paid at the death of the grantor or the grantor’s spouse. This also results in any appreciation on trust assets passing free from the federal gift and estate tax.[3] The prospect of a reduction to the Exemption, especially if retroactive, creates a “use it or lose it” mentality. If taxpayers do not use their Exemption before such reduction is effective, they will be limited to the new Exemption amount. Whereas if taxpayers utilize their Exemption now, and the Exemption decreases, there is no clawback for using the higher amount while it was in effect. For more details on the benefits of lifetime gifting, see Charles J. Allen’s recent article.[4]

One of the downsides to lifetime gifting is that the gifted assets will no longer be available for use by the grantor directly, such that taxpayers may be afraid that they will end up needing some or all of these assets. This creates contrasting goals for taxpayers, where on one hand they want to transfer as much of their assets as possible to benefit from lifetime gifting, but on the other they want to ensure that they will retain enough assets for their needs.

The contrast between these goals is mitigated somewhat for a SLAT, and such mitigation is likely what many taxpayers find so attractive about SLATs. Because the assets transferred to the SLAT are to be used for the benefit of the grantor’s spouse, the grantor may receive an indirect benefit from the trust since the interests of the beneficiary spouse typically coincide with those of the grantor. For example, if the couple were unable to afford the mortgage payment on their primary residence, the trustee of the SLAT might use the SLAT income or assets to make such a payment on behalf of the beneficiary spouse as a distribution for the spouse’s maintenance and support.[5] Further, there are a multitude of strategies for providing the grantor spouse access to additional assets upon the beneficiary spouse’s death. These strategies include wealth replacement life insurance, allowing the grantor spouse to borrow from the SLAT, granting the beneficiary spouse a testamentary power of appointment in favor of the grantor spouse (though one must be careful not to create an implied understanding that the SLAT assets would be appointed back to the grantor spouse), and using special power of appointment trust and domestic asset protection trust provisions in the residuary trust.

Reciprocal SLATs

The hesitance to part with assets during life can be further mitigated, and the value of assets eligible to pass without being subject to the federal gift and estate tax can be doubled, if both spouses establish a SLAT. For example, assume a couple has $24 million in assets. If each establishes a SLAT for the benefit of the other, each spouse could have a SLAT with $12 million in assets available for their needs, even though they would no longer have direct access to the full $24 million.[6] When compared to other methods of lifetime gifting, such as by giving the full $24 million to a trust for the couple’s descendants in which they would have little to no interest, one can definitely see the appeal of SLATs.

Taxpayers should always be wary of anything that sounds too good to be true, because it usually is. See Josh Sage’s recent articles discussing cases involving promoted “tax plans.”[7] If not drafted and administered properly, SLATs can fall within the reciprocal trust doctrine. The law for when the reciprocal doctrine applies has developed overtime, but generally, trusts must be interrelated and the arrangement must leave the two grantors in approximately the same economic position as if they had the created the trusts and named themselves as beneficiary, as determined by a multitude of factors.[8]

If the reciprocal trust doctrine applies, the SLATs are “uncrossed,” such that each spouse is treated as gifting assets to a trust established for their benefit.[9] This results in the respective trust assets being included in the respective grantor’s taxable estate at the full fair market value of the assets on the date of death, including any appreciation since the assets were transferred to the SLATs.[10] This situation can also create the issue of a self-settled trust, thus introducing the possibility of spendthrift language being ineffectual as to the deemed beneficiary grantor.

Preventing the Reciprocal Trust Doctrine

Obviously, if the reciprocal trust doctrine applies, most of the taxpayers’ intended tax consequences in establishing the SLATs are foiled. Taxpayers should therefore take precautions to reduce the likelihood of this outcome. The first step in reducing the likelihood of the reciprocal trust doctrine applying is to properly structure the two SLATs with significant differences. The following are several such structural differences which may be implemented:

  1. Establish the trusts at different times, preferably in different tax years.
  2. Provide different termination dates and events.
  3. Ensure different trustees.
  4. Fund the trusts with different assets and ensure different values.[11]
  5. Provide different distribution standards.
  6. Have one trust consider the beneficiary spouse’s outside resources while the other does not.
  7. Provide that one of the spouses become a discretionary beneficiary only after the lapse of some specified time or on the occurrence of some event.[12]
  8. Have one trust include the spouse as a discretionary beneficiary but the other trust gives an independent party (not exercisable as a fiduciary), possibly after the passage of some specified time, the authority to add the other spouse as a discretionary beneficiary.[13]
  9. Have one trust allow conversion to a 5% unitrust but while the other does not.
  10. Include withdrawal powers in one trust but not in the other.[14]
  11. Provide different powers of appointment.[15]
  12. Provide different powers to remove and replace trustees.

Regardless of how well the SLATs are drafted, the structure serves merely as a foundation, which can certainly be undermined if the SLATs are not administered properly. This is one of the key reasons that many practitioners recommend that a professional or corporate trustee be appointed for SLATs. Taxpayers need to be diligent that the terms of the SLATs are respected, else the IRS might not respect them either.

Shortly after funding the trusts, some clients may want to immediately start flowing cash out of the SLATs to each other the same as they did before the SLATs were created. If clients take this action, the IRS would likely argue the existence of a pre-arranged plan whereby the income or other benefits of the assets in the SLATs revert to the respective grantor, even if only indirectly through their spouse. If the IRS were successful in such an argument, the assets in the SLATs, including appreciation, would once again be included in the taxable estate of the respective grantor spouse.

Summary

SLATs have become one of the most popular planning strategies implemented by taxpayers to use their Exemption during their lifetime. With the Exemption set at $12.06 million, but scheduled to decrease in 2026, now is a great time to get assets (especially those that are expected to appreciate) out of taxpayers’ taxable estates. Many taxpayers may have reservations about transferring the bulk of their assets to a trust in which they have little to no interest. As we have said time and time again, the tax tail should not wag the dog. Depending on the specifics of the taxpayer, this hesitancy can potentially be alleviated by having married couples establish SLATs for each other’s benefit. Taxpayers should be careful that the SLATs are properly structured and administered to ensure that the desired tax treatment is accomplished.

[1] See exemption amounts on the IRS Estate Tax webpage at https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax.

[2] §2010(c)(3)(C).

[3] It should be noted that appreciation may not be free from income tax upon disposition after the grantor’s death.

[4] Charles J. Allen, The Pros and Cons of Lifetime Gifting (November 29, 2021), https://esapllc.com/lifetime-gifting-2021/.

[5] Note that using trust assets to satisfy a legal obligation the settlor spouse may otherwise have to support the beneficiary spouse could cause additional concerns.

[6] Note that if the assets are the joint property of the spouses, additional steps will likely need to be taken before using them to fund the SLATs.

[7] Joshua W. Sage, Fab Holdings – It is called the “Tax Plan” (January 11, 2022), https://esapllc.com/fab-holdings-2021/ and Once Again, the “Tax Plan” Fails (February 22, 2022), https://esapllc.com/larson-2022-blips/.

[8] A full discussion of the law surrounding the reciprocal trust doctrine, even as it relates directly to SLATs, is beyond the scope of this article. However, see the following cases and rulings: Lehman v. Comm’r, 109 F.2d 99 (2nd Cir. 1940) (original reciprocal trust case); Estate of Grace, 395 U.S. 316 (1969) (established two prong economic position and interrelated test); Estate of Bruno Bischoff, 69 T.C. 32 (1977) (fiduciary powers to retain income – taxpayer loses); Estate of Green v. U.S., 68 F.3d 151 (6th Cir. 1995) (fiduciary powers to retain income – taxpayer wins); Estate of Herbert Levy, T.C. Memo. 1983-453 (1983) (differing powers of appointment); Private Letter Ruling 9643013 (differing remainder beneficiaries and powers of appointment); and Private Letter Ruling 200426008 (differing withdrawal powers and remainder interest for grantor).

[9] Estate of Grace, 395 U.S. 316 (1969).

[10] Id.

[11] Grace holds that just having different assets is not sufficient to avoid being reciprocal trusts, but it applies only to the extent of mutual value, Estate of Cole v. Comm’r, 140 F.2d 636 (8th Cir. 1944).

[12] See PLR 200426008.

[13] Similar to PLR 200426008.

[14] See PLR 200426008.

[15] See Levy, where an inter vivos POA was included in one trust but not the other. See also PLR 9643013.