Now may be the time to consider a Spousal Lifetime Access Trust (SLAT)

With the upcoming election and potential tax law modifications based on the outcome, high net worth married couples should consider meeting with their advisors to determine what they can do to prepare for potential tax changes. One strategy worth consideration is a Spousal Lifetime Access Trust, commonly referred to as a SLAT.

A SLAT is a gift from one spouse to an irrevocable trust for the benefit of the other spouse. Unlike other types of credit shelter trusts, a SLAT is funded while both spouses are still living. The beneficiary spouse can receive distributions from the SLAT even though it is designed to be excluded from the beneficiary spouse’s gross estate and not be subject to estate tax when the beneficiary spouse dies.

It may be a good time to take advantage of a SLAT because there could be a decrease in the federal gift and estate tax exemption, which is currently at $11.58 million per person or $23.16 million for a married couple. For example, if a President Biden and Democrat-controlled Congress passed tax legislation in 2021 that lowered the exemption to $3.5 million (a number that has been mentioned), this could be made retroactive to the beginning of the year. But if the SLAT was funded in 2020, you will not be adversely affected if the amount is decreased.

There are many pros and cons of SLATs to take into consideration. Below are some FAQs regarding SLATs:

What is a Spousal Lifetime Access Trust (SLAT)?

It is a trust that you (the grantor) set up for the benefit of your spouse and your descendants. You would make a gift to the SLAT, using some of your federal lifetime gift exemption (currently $11.58M in 2020) to shield that gift from gift tax. While you give up all your rights and control over the gifted assets, your spouse will have access to the gifted assets as beneficiary of the SLAT.

When does it make sense to have a SLAT?

You should consider creating a SLAT if you have a federally taxable estate and want to reduce your taxable estate by making lifetime gifts. While making lifetime gifts requires you to give up all your rights to the gifted assets, the SLAT provides a safeguard, because your spouse can receive trust distributions as beneficiary, which she can use for your joint support and maintenance as needed. So, if you are hesitant to give away assets because you will no longer have any access to those assets, a SLAT may be the solution for you.

How much can I gift to my SLAT?

The Tax Cuts and Jobs Act of 2017 (“TCJA”) increased the federal estate and gift exemption from an inflation adjusted $5M per person to $10M per person. For 2020, each of us can gift $11.58M free of gift tax. However, this TCJA provision is scheduled to expire by the end of 2025 with the exemption reverting to $5M per person, adjusted for inflation. Congress can also lower the exemption amount at any time prior to this scheduled expiration date. With the need to fund COVID-19 related stimulus spending, the federal government may need to raise revenue sooner rather than later and could look to increase estate and gift tax revenue by lowering the federal estate and gift exemption. Because of this, there may be a “use it or lose it” opportunity here. Currently, you can fund a SLAT with $11.58M gift tax-free. If you wait until next year and Congress lowers the gift exemption to $6M in 2021, you may miss the opportunity to transfer an additional $5.58M free of gift tax out of your taxable estate.

Is a SLAT includible in my estate or my spouse’s estate?

No. If structured correctly and administered properly, the SLAT will be excluded from your taxable estate and your spouse’s taxable estate when you are both gone.

What happens if my spouse predeceases me or my spouse and I get divorced?

If your spouse predeceases you or if you get a divorce, you will lose the indirect access to the SLAT funds you had through your spouse. To remedy this, the SLAT should be drafted to ensure only your current spouse is a trust beneficiary (not a former spouse). The SLAT can also give your spouse the power to direct the funds back to you upon her passing, if needed. It can also make loans to you.

Can both my spouse and I set up separate SLATs for each other?

Yes. If you and your spouse set up SLATs for each other, they must not mirror each other. If the two SLATs are too similar, the IRS will ignore both of them for gift tax purposes. To avoid this, the SLATs can be created and funded on different days, have different rules for making trust distributions and be funded with different types of assets.

Who can be the trustee of my SLAT?

As grantor, you may not act as a trustee. Your beneficiary spouse may act as a trustee, but if so, trust distributions should be subject to an ascertainable standard, such as distributions for a beneficiary’s health, education, maintenance or support only. Naming an independent trustee who is not a trust beneficiary will provide more flexibility, as the independent trustee could have broad discretion to make trust distributions for any reason.

Does the SLAT pay its own income taxes?

Generally, SLATs are set up as grantor trusts, so for income tax purposes the grantor and the SLAT are treated as the same taxpayer. A SLAT is a separate legal entity for ownership purposes, but it is ignored for income tax purposes. So even though the trust’s assets are excluded from your taxable estate, its income and deductions are reported on your personal income tax return and you pay the income taxes on the SLAT’s income. Paying the tax on the SLAT’s income each year allows you to further reduce your taxable estate without gift tax consequences, while allowing the SLAT to grow income tax-free over time.

It is best to talk to your estate planning attorney and determine if a SLAT is the right option to allow you to take advantage of the favorable estate and gift tax exemption. Just be aware that there is a chance your window may close at the end of this year, so do not procrastinate.