February 2023 – By Tom Rueger, J.D., CFP®
Fred and Wilma have done well during their lifetime and accumulated a significant net worth. Now they are looking into their options for estate planning. The 2017 Tax Cuts and Jobs Act increased the federal lifetime gift and estate tax exemption to $12.92M/$25.84M for 2023, but it is set to expire on 1/1/2026 (and revert back to the prior amount of $5M, adjusted for inflation). Fred and Wilma are concerned that their estate will be liable for significant taxes if the exemption returns to its prior amount in a few years. They want to remove assets from their estate without making current gifts to their children as they are concerned it might affect their future standard of living. A SLAT could be the solution.
A SLAT (Spousal Lifetime Access Trust) can be an effective wealth transfer strategy to consider while the estate tax exclusion remains at historically high levels and if the donor spouse (called the Grantor) has sufficient assets remaining outside of the SLAT to support their lifestyle. A SLAT can provide potentially substantial tax savings now that are not guaranteed in the future. It may be a use it or lose it scenario.
More specifically, a SLAT is an irrevocable trust where one spouse makes a gift into a trust to benefit the other spouse (and potentially other family members down the road) while removing assets from their estate to avoid federal estate taxation. The donor spouse effectively gives up control and beneficial interest in the assets that are gifted. The trust assets are excluded from the donor spouse’s and the non-donor spouse’s taxable estate. It is important that only assets owned by the donor spouse individually are gifted into the SLAT. Using assets owned by both spouses would negate the benefits of the SLAT.
Example 1: Fred and Wilma have joint and separate assets totaling $30 million, which will continue to appreciate while they are still alive. If they both were to transfer $12.92 million of their own separate assets into two SLATs benefitting each other, they could exclude the total $25.84 million, plus any future appreciation and income, from their taxable estate while still helping from those assets. Fred and Wilma would then have the remaining $4.16 million in shared assets, plus their SLAT distributions, to support their income needs.
Example 2: Fred and Wilma have joint and separate assets totaling $15 million. $12 million is owned individually by Fred. These assets will continue to appreciate while they are still alive. If Fred were to transfer the entire $12 million of his own separate assets into a SLAT benefitting Wilma, Fred would be able to exclude the total $12 million, plus any future appreciation and income, from his taxable estate while still helping from those assets. Fred and Wilma would then have the remaining $3 million in shared assets, plus their SLAT distributions, to support their income needs.
Some Technical Details:
The donor spouse cannot benefit from the trust (have access to or control over the assets) but the non-donor spouse has access to the assets inside the trust with certain limitations. This allows the donor limited indirect access to the trust assets.
Any post-gift appreciation in the trust will also be excluded from the estate of both spouses for federal estate tax purposes. It is a mechanism that allows for the appreciation of assets outside of the donor’s estate for the benefit of their descendants.
There is no “Clawback” of previously gifted amounts (Treasury Department Final Reg IR-2019-189), even if the federal lifetime gift and estate tax exemption reverts to the 2017 amount of $5M (adjusted for inflation).
A SLAT can also be a beneficial strategy for individuals that reside in a state that has a state estate tax, even if they do not expect to be subject to a federal estate tax.
Upon the death of the non-donor spouse, the donor spouse no longer has indirect access to the trust assets.
In the event of divorce, the separated non-donor spouse will continue to benefit from the trust as a beneficiary while the donor spouse will lose indirect access just as if the non-donor spouse had passed away. However, divorce risk can be alleviated by a provision that terminates the non-donor spouse’s beneficial interest in the trust in the event of divorce.
Assets transferred into the SLAT could lose any “step-up” in basis that might otherwise be available upon the donor’s death.
To fully utilize both exclusions, each spouse may create a SLAT for the benefit of the other. However, careful planning must be done to avoid the “reciprocal trust doctrine” that applies when the IRS interprets the 2 trusts as constructively similar or interrelated.
If you would like to know more about utilizing a SLAT, please reach out to your Wealth Advisor to discuss the impact on your overall financial plan.
Fred and Wilma are fictitious and are being used only as an example. They are not actual clients of Vantage Financial. This material is for informational purposes only. It is not a recommendation or solicitation to buy or sell any securities. Vantage Financial is not a tax advisor or estate planning attorney; please consult your tax advisor or estate planning attorney prior to making any decisions. Vantage Financial is an Investment Advisory Firm registered with the Securities and Exchange Commission (“SEC”). SEC registration does not imply any particular level of skill or expertise.