SLATs and Their Tax Advantages

A Spousal Lifetime Access Trust ("SLAT") is an irrevocable trust that allows a grantor to gift property to his or her heirs during the grantor's lifetime, while allowing the grantor's spouse to benefit from the trust income and principal until the spouse dies.  Sounds simple, but there's a few key things happening in between the lines that highlight the benefits of this estate planning tool. 

Grantor as Beneficiary

First, by naming the grantor's spouse as the lifetime beneficiary of the trust, the grantor hopes to benefit thereby.  A monetary gift to one's spouse will undoubtedly be used to benefit that granting spouse in some way, especially if both spouses engage in this type of gifting.  But why would both spouses give this similar gift? 

Federal Estate Tax Advantages

Enter benefit number two, which comprises the main benefit offered by SLATs.  When this gift is made, it pulls that gift out of the grantor's estate for federal and state estate tax purposes.  In other words, if a grantor gives $5 Million to his children during life while giving his spouse (i.e. himself) lifetime access to the trust, that $5 Million will not be part of the grantor's taxable estate at death.

For federal estate taxes, this benefit will be very important under the new tax regime that went into effect January 1, 2018, and which sunsets on January 1, 2026.  The tax changes increased the federal estate tax exemption from the $5 Million indexed schedule to a $10 Million indexed schedule, essentially doubling the exemption.  Remember that this applies to a person's taxable estate at death as well as gifts given during the grantor's life.  So the $5 Million gift discussed above will have the same effect to use that portion of the exemption.  However, if no new legislation is passed making this change permanent, then on January 1, 2026, the exemption will go back to the $5 Million indexed schedule. 

To illustrate, if high net worth individuals fail to either die during the period of the increased exemption or to give away property up to the full increased exemption amount, then they'll lose their opportunity to significantly reduce their taxable estate.  If a grantor does nothing until 2026, then an individual with more than $11.2 Million in assets will miss out on reducing his or her estate tax liability (what will actually be paid to the government at death) by $2.24 Million dollars!  Wow!  Do nothing, and you reduce your children's inheritance by $2.24 Million, which goes straight to Uncle Sam!  For married couples filing jointly, the numbers double.  So if you and your spouse have over $22.4 Million in assets and do nothing until 2026, you miss out on reducing your dollar-for-dollar tax liability by about $4.5 Million.  Therefore, SLATs can be a great tool for taking advantage of the increased federal estate tax exemption when you know that exemption will eventually drop.

State Estate Tax Advantages

For individuals and couples whose net worth does not exceed the current increased federal estate tax threshold, but who live in states that have a separate estate tax, SLATs can significantly reduce you state estate tax liability.  As long as that state does not have a gift tax tied its estate tax exemption, a SLAT can be used to reduce the grantor's estate below the state estate tax threshold while still benefitting from the gifted assets (remember, a gift to your spouse is essentially a gift to yourself).  For example, Minnesota's estate tax exemption will be capped at $3 Million, and lifetime gifts do not count toward that exemption unless they're made within 3 years of the grantor's death.  So a Minnesota resident with a $5 Million estate who gives away $2.5 Million in a SLAT will effectively avoid any Minnesota estate tax liability at death, as long as the SLAT is funded more than 3 years before the grantor dies.

Warning – The Reciprocal Trust Doctrine

The IRS has caught on to this tactic of avoiding tax liability in the situation where spouses make reciprocal gifts to each other.  When a married couple gets their estate plan done at the same time, and their plans essentially mirror each other, if a SLAT is part of that mirroring plan, the IRS will find that the gifts are reciprocal.  When this happens, the gifts fail to pull the assets out of the grantor's estate, and the estate tax advantage is lost.  To avoid this result, grantors could work with their estate planning attorney to vary the terms of the differing trust, such as the amount with which the trust is funded, the powers of the trustee, the beneficiaries, or the spouse's right to income or principal.

To take advantage of the current tax climate by using a SLAT as part of your comprehensive estate plan, talk with one of our South Dakota, Iowa, or Nebraska estate planning attorneys.