Over the past couple of months, we have been discussing the federal estate tax law in this space, including the current state of the law, changes President Biden has proposed, and some general strategies to deal with possible changes to the federal estate tax. Now it’s time to take a closer look at some of the individual strategies that are available to minimize the tax burden on your estate.
It’s true that the great majority of Americans’ estates will not be subject to federal estate tax due, in part, to the significant lifetime federal estate tax exemption. As of 2021, that exemption is at a historic high: $11.7 million dollars for an individual, or $23.4 million for a married couple. People whose estates do not exceed those exemption amounts will not have to pay federal estate tax.
When then-President Trump signed the Tax Cuts and Jobs Act (TCJA) into law in 2017, the lifetime exemption doubled, and it has increased every year since. However, under the TCJA, the lifetime exemption is slated to revert to $5 million, adjusted for inflation, after December 31, 2025. (However, the current administration could choose to reduce the exemption even sooner.)
One of the general strategies we have recommended is to take advantage of the current lifetime exemption amount before it decreases, making gifts that will reduce your taxable estate before the exemption amount decreases. One way to reduce your taxable estate but maintain flexibility is to create a Spousal Lifetime Access Trust, or SLAT, as part of your estate plan.
A SLAT is a type of irrevocable trust, meaning that once you put assets in the trust, you cannot unilaterally take them back. You, as the grantor of the trust, establish the trust for the benefit of your spouse and descendants (or other beneficiaries, if you choose). To fund the trust, you make a gift to the trust of some or all of your assets, which utilizes your lifetime exemption (up to $11.7 million in 2021).
Because you are placing those assets in a trust from which you cannot reclaim them, those assets will also be removed from your taxable estate. But as beneficiary of the SLAT, your spouse will have access to those assets. That means you may still benefit from those assets (through your spouse) even though you can no longer control them yourself.
What’s more, you will have made that gift to the trust tax-free; even when the lifetime exemption amount is reduced, it is unlikely to be reduced retroactively. In other words, had you waited to make a gift or bequest of those assets, they might have been taxable. Because you made the gift when the lifetime exemption amount was high, it is not.
We’ve already discussed the primary advantages of SLATS: they allow you to make a large gift, tax-free, to a trust for your spouse’s benefit. Furthermore, although you can’t take those assets back, as long as you are married to your spouse, you may have the use and enjoyment of them.
That said, there is a potential downside to estate planning with a SLAT. First is the irrevocable nature of the trust. This permanence may work perfectly well as long as you and your spouse are happy together. But if your spouse decides to divorce you, they are still the beneficiary of the trust and the potentially millions of dollars of assets you placed in it. Your attorney could draft the trust with that in mind, for instance saying that the trust is intended only for the benefit of a current spouse. However, if your estate planning attorney is representing both you and your spouse in creating an estate plan, protecting your interests at the expense of your spouse could be problematic from an ethical, conflict-of-interest standpoint.
What about when the first spouse passes away? In such an instance, the assets in the trust might pass to the remainder beneficiaries, skipping the surviving spouse altogether. Possibly worse, provisions in the SLAT that do provide for the surviving spouse, if not drafted extremely carefully, could actually undo the estate tax exemption planning done at the outset.
It is possible for you to create a SLAT for your spouse’s benefit using your lifetime exemption, and for your spouse to create a SLAT for you using theirs. However, there is a caveat. If the trusts you create are too similar, the so-called “reciprocal trust doctrine” may come into play. The Internal Revenue Service may conclude that the SLATs are too similar or even identical, and that they cancel each other out. In effect, you would have each created a trust for your own benefit, which would not be permissible.
However, there are steps you can take to ensure that your SLATs do not trigger the reciprocal trust doctrine. You can make the trusts at different times; the further apart in time, the better. You could create a trust for your spouse this year, and they could create one for your benefit in a year or two.
Another way to avoid the trusts mirroring each other would be to vary the terms of distributions. Perhaps you create a trust to make distributions for your spouse’s health, education, maintenance and support. Your spouse’s trust for you might make distributions of income or principal for any reason. Distributions to remainder beneficiaries could be structured differently as well. You could also choose to have different, independent trustees for each trust. Regardless, careful planning and drafting are required to avoid application of the reciprocal trust doctrine.
If a SLAT is structured properly and administered correctly, assets in the trust will not be included in your estate nor in your spouse’s when you are both deceased. With four convenient Ohio locations, we invite you to contact Gudorf Law to schedule a consultation if you are interested in creating a SLAT for your spouse’s benefit.