Since the 2017 Tax Cuts and Jobs Act, the lifetime estate and gift tax exemption has been historically high – $12.92 million for individuals and $25.84 million for couples. Without congressional action, the estate tax exemption is currently scheduled to expire on December 31, 2025, and the inflation-adjusted exemption will return to approximately $7 million ($14 million for couples). Due to these expected changes, high-net-worth individuals and families should review their estate plans to see if it might be beneficial to make additional lifetime gifts to use the exemption before they potentially lose it.
One strategy that might be utilized to make a lifetime gift is an irrevocable grantor trust called a spousal lifetime access trust (SLAT) that allows the donor spouse to have indirect access to gifted assets by means of the beneficiary spouse. One spouse makes a gift into the trust for the benefit of the other spouse (and possibly other family members), thereby removing the assets along with any post-gift appreciation from their combined estates. Upon the death of the non-donor spouse, the assets are transferred to the remaining trust beneficiaries such as children or grandchildren, either outright or in further trust.
There are several advantages to establishing SLAT trusts as a means of lifetime gifting. While the donor’s transfer of assets to the SLAT is a taxable gift and a gift tax return should be filed, a gift tax may not be owed if the donor utilizes their Federal gift and estate tax exclusion. The trust assets are excluded from the beneficiary spouse’s estate as well. SLAT’S are typically grantor trusts, which means the donor (who has a lower tax bracket) rather than the trust pays the income tax on earnings. The assets inside the trust are allowed to appreciate outside the estate of the donor and the spouse. Even if the donor’s estate is not large enough to be subject to federal estate tax, a SLAT may be a good strategy for individuals who reside in states with a state estate tax.
One reason that individuals often do not use irrevocable trusts for lifetime gifts to remove the assets from their estate is that, by definition, to make a completed gift, they have to give up control of the assets. While establishing a SLAT still involves giving up control of the assets to the trustee, the donor retains some indirect control over the assets by virtue of the fact that his or her spouse is the beneficiary of the trust. This distinction can make a SLAT trust more palatable than other irrevocable grantor trusts. These trusts can also provide creditor protection.
While SLAT’s can be good planning tools, there are a few important things to consider before establishing a SLAT:
- At the death of the non-donor spouse, the donor spouse will no longer have indirect access to trust assets as the trust may either terminate or be distributed to remaining beneficiaries. Provisions should also be included in the trust that the non-donor beneficiary loses his or her beneficial interest in the trust in the event of a divorce.
- The spouse establishing the trust should consider naming an independent co-trustee to serve with the non-donor spouse to avoid potential inclusion of trust assets in the non-donor spouse’s estate if he or she has broad discretion over trust distributions.
- The transfer of assets to a SLAT removes the assets from both spouses’ estates. Since the assets are out of their estates, the assets will not receive a “step-up” in basis at the death of either spouse. The trust may allow the donor to swap low basis assets for high basis assets.
- The donor must be careful to only transfer assets to the SLAT that are owned by the donor and not owned jointly. Otherwise, the SLAT could be negated because the gift could be treated as being made by both spouses. Individuals who live in community property states need to be especially aware of this caveat and may need additional documentation.
If you are potentially subject to the estate tax, you may want to talk to your financial planner and attorney about the possibility of making wealth transfers now, such as transferring assets to a SLAT. A SLAT can be a very effective planning tool to pass wealth to the next generation without incurring estate and gift taxes or generation skipping transfer tax.