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While historically high federal transfer tax exemptions remain in effect, the Spousal Lifetime Access Trust (“SLAT”) (also sometimes referred to as a Spousal Estate Reduction Trust, or “SERT”) remains one of the most effective planning techniques for married clients.

What is a SLAT?

A SLAT is an irrevocable trust in which the spouse is a permitted beneficiary. It allows married clients to take advantage of the high gift tax exemption amount while also allowing continued access to the gifted trust assets, if needed, while removing any appreciation on the gift from each spouse’s taxable estate. A SLAT can also be structured as a Dynasty Trust by naming children and grandchildren as additional beneficiaries and allocating GST exemption to the trust.

How Does a SLAT Work?

With a SLAT, one spouse (the grantor) transfers assets to an irrevocable trust for the benefit of the other spouse (the beneficiary). The grantor spouse applies their gift tax exemption to the gifted trust assets, and all post-transfer appreciation of the SLAT assets are shielded from future gift, estate, and GST taxes. While it is desirable to allow the trust assets to continue to grow in the trust free of transfer tax, if the beneficiary spouse needs assets from the trust in the future, a trustee can make a distribution to the beneficiary spouse. For this reason, SLATs are desirable to clients who want to make large, irrevocable gifts while leaving open the possibility that a spouse could benefit from the trust if necessary.

How is a SLAT Taxed?

A SLAT is structured as a “grantor trust” for income tax purposes. This means that the income of the SLAT is reported on the grantor’s individual federal income tax return. This is, in fact, advantageous because payment of this tax will reduce the grantor’s taxable estate and allow the assets in the trust to appreciate free of income taxes. If the payment of taxes on behalf of the SLAT becomes too burdensome, there are a few options for how to alleviate that burden, such as reimbursing the grantor for taxes paid or due or loaning trust assets to the grantor to pay the tax.

What Are the Benefits of a SLAT?

A SLAT offers several protective measures for the assets held within it, including:

  • Estate Tax Protection. Assets transferred into the SLAT are shielded from estate taxes upon the death of the grantor and future beneficiaries of the trust.
  • Creditor Protection. The assets held within the SLAT should be safeguarded from claims by creditors of any trust beneficiary as well as claims by creditors of the grantor (assuming no fraudulent transfer).
  • Divorce Protection. In the event of a divorce, the assets within the SLAT should be shielded from being divided by a court.
  • Investment Management. A SLAT is designed to accept assets the grantor transfers, allowing investments to be made on behalf of the grantor’s beneficiaries. The trustee of the SLAT is tasked with utilizing the trust assets for the welfare and support of the beneficiaries throughout their lifetimes, ensuring that the beneficiaries receive necessary assistance and resources from the trust as intended by the grantor.

What Are Some Risks of a SLAT?

While considering the implementation of a SLAT, it is crucial to be aware of various risks associated with this planning technique:

  • Irrevocability. Once assets are transferred to a SLAT, the gift becomes irrevocable, meaning it cannot be undone. This underscores the importance of careful consideration and planning before funding the trust.
  • Compliance with Technical Rules. Proper funding and administration of the SLAT require adherence to technical rules. Failure to follow these rules could undermine the trust’s effectiveness in achieving its goals.
  • Avoiding Reciprocal Trust Doctrine Violations. If a married couple each sets up a SLAT for his or her spouse, it is essential to ensure that the SLATs do not violate a tax law concept known as the “reciprocal trust doctrine.” Under the Reciprocal Trust Doctrine, the Internal Revenue Service argues that if spouses each create trusts of which the other is a beneficiary and which have identical terms, each trust is deemed to have been created “in consideration” for the other. Based on this premise, the IRS then concludes that the substance of the transaction is as if each spouse had created a trust for his or herself, thereby causing each trust to be included in the grantor’s taxable estate at death. To avoid the application of the Reciprocal Trust Doctrine, the dispositive terms of the SLATs must vary in meaningful respects.
  • Asset Protection in Divorce. Assets held within the SLAT may not be retrievable in the event of divorce. This emphasizes the need for careful consideration of asset ownership and protection strategies.
  • Lack of Basis Adjustment. Upon the grantor’s death, assets held within the SLAT may not receive a basis adjustment, potentially affecting future tax implications for beneficiaries.
  • Risk of Death of Divorce.  The main attraction of a SLAT is the possibility that a spouse could benefit from the trust if necessary.  A SLAT can only benefit the spouse beneficiary and indirectly the grantor spouse at such time as the spouse is a trust beneficiary.  Therefore, in the event of a divorce between the spouse and the grantor or in the event of the spouse beneficiary’s death, the grantor loses his or her indirect access to the SLAT.

How is a SLAT Funded?

  • Gifting Assets. The grantor can leverage their lifetime gift tax exemption to transfer assets to the SLAT. Utilizing this exemption allows the grantor to transfer assets to the SLAT without incurring gift taxes. The transfer is contingent upon the grantor having sufficient lifetime gift tax exemption available. This strategy provides a tax-efficient method for funding the SLAT and transferring wealth to intended beneficiaries.
  • Loaning Assets. The grantor can lend assets to the SLATs, enabling them to engage in investments. Interest payments on the promissory note should not trigger income taxes due to the disregarded status of the SLATs for income tax purposes, a consequence of their grantor trust classification.
  • Selling Assets. In addition to establishing SLATs and leveraging the grantor’s lifetime gift tax exemptions, another strategy involves selling appreciating assets to the SLATs in exchange for a promissory note. The promissory note can be structured with favorable terms, offering flexibility to accommodate the actual financial performance of the transferred assets. If the asset sold is a business interest, the promissory note may be paid with tax distributions, providing a tax-efficient method for repayment.

Example: if the SLAT owns shares in an S-Corporation, distributions received by the SLAT to cover income tax liability (or income from transferred assets) can be used to make payments to the grantor under the promissory note. The grantor can then utilize these funds to settle the income taxes due on the allocated income. Interest payments on the promissory note and the sale of assets to the SLAT are not expected to trigger income or capital gains taxes due to the SLAT’s disregarded status for income tax purposes, attributed to their grantor trust classification. Appreciation on the assets beyond the interest rate payable on the note is expected to avoid taxation, providing additional tax benefits.

Summary

While SLATs provide married couples with a flexible, tax-efficient estate planning opportunity, some risks exist. It is crucial to connect with your Wiggin and Dana attorney to discuss whether SLATs are appropriate for you and your family. With thorough planning, regulatory compliance, and consideration, utilizing a SLAT can be valuable to your overall estate planning strategy.

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