Spousal Lifetime Access Trust

What is a Spousal Lifetime Access Trust (SLAT)?

A Spousal Lifetime Access Trust or “SLAT” is an Irrevocable Trust that:

• Provides specific support for a spouse for life
• Is excluded from the taxable estates of both spouses
• If everything goes as planned, ultimately passes more than the exclusion amount to the children or other designated beneficiaries

It is a very powerful tool for estate planning and asset protection.

How does a SLAT work?

A SLAT works by taking advantage of two exclusions from transfer taxes:

• the unlimited marital deduction, and
• the lifetime exclusion amount.

All gifts or transfers of property from one person to another are taxable.  (See FAQ).  There are, however, a number of exclusions from transfer taxes.

The unlimited marital deduction allows married persons to make an unlimited amount of gifts or transfers between them without triggering a transfer or gift tax.  (26 U.S. Code § 2056).  The lifetime exclusion amount is the one time amount that may be gifted without incurring a transfer tax.  (26 U.S. Code § 2010).  The trick is, although these exclusions are most often used at death, they can also be used while living.  When these exclusions are used together, the gifts can be leveraged in powerful ways.

Funding a SLAT is a type of Split Interest Gift.  The gifted property is essentially split into its present income value and its residual value at the spouse’s passing.  The Grantor or Settlor gifts the present income interest to the spouse.  The potential value of this gift may be in any amount without triggering a gift tax because of the unlimited deduction.  The Grantor also gifts the future residual value of the corpus to the children or other beneficiaries.  The value of this gift of a future interest is capped at the lifetime exclusion amount.  Otherwise, it triggers a tax.

This is where the magic happens.  The gift to the children or other beneficiaries is a future interest, not a present interest.  This means its value for gift tax purposes is not its present value, but its future value.  The future value of the remainder interest is calculated using IRS table 7520.  The value is based on the spouse’s expected mortality as determined by the applicable IRS section 1457 table.   The reasonable medical expectancy of the spouse receiving the lifetime income is also a factor.  Simply put, the present value is determined by multiplying the present fair market value of the gifted property by the corresponding life interest actuarial factor.  Of course, there must be valuations, and the valuation methods and gifts must all be reported on the appropriate gift tax returns.  This requires the legal, accounting, and valuation professionals to work together as a team.

The remainder interest valuation based on IRS tables is better than what is called a “discount”.  A discount is where the value of an asset is impaired because of some factor like lack of marketability or lack of control.  With a Spousal Lifetime Allowance Trust, the value of the gift to children is less because the children don’t actually get anything until the spouse dies.  The value of such a future interest is determined by specific IRS codes and tables, not merely a market appraisal.

What does all this technical jargon mean?  It means that under the right circumstances, a SLAT can be funded with significantly more than just the lifetime exclusion amount.  It also means that the estate tax exempt portion of the family’s net worth will increase over time with appreciation and income.  In other words, for very large estates, a SLAT is a powerful tool for transferring wealth to future generations while minimizing the overall tax consequences.  It means more for the family and less for the politicians.

With more wealth in the family and less going to taxes, it is even more important for a SLAT to be structured as a “dynasty trust.”

What are the Income Tax Consequences of a SLAT ?

Distributions of income (and principal) from a SLAT to both the spouse and the children may be automatic, age based, or discretionary.  In some instances, “income” may be attributed to one party separate from “distributions” of cash or other benefits.  The allocation of income among the various parties will alter the ultimate tax liability.  This gives rise to tax planning opportunities.  Someone is going to pay taxes on the income.  There may be benefits from selecting among the Grantor, the spouse or the children to pay the income taxes.

In most estates large enough to enjoy the full benefit of a SLAT, the most tax efficient move will be to make the SLAT “Intentionally Grantor Defective” so that the Grantor spouse pays the income tax.  This may be counter intuitive for the Grantor when the income tax liability goes up.  However, in simple terms, when the Grantor pays the ongoing income taxes, it reduces the eventual estate tax.  Taxes are paid, but the net net net long term tax total liability for the family as a whole is reduced.

One consequence that may be considered a down side is the loss of step up in cost basis at death.  This means the gifted assets will have a carry forward cost basis, and future appreciation will be subject to applicable capital gains taxes.  So far, the capital gains tax rates have been less than the marginal estate tax rates.  Perhaps more significant, capital gain taxes can deferred or avoided in a variety of ways, whereas death and its resulting taxes are ultimately not avoidable.  If you have to pick one, capital gains are the best bet.

Are there Unintended Estate Tax Consequences of a SLAT?

It is critical to make sure the SLAT is not funded with community property.  Otherwise, the gift will be imputed as coming from the spouse to the spouse.  In community property states, a property agreement between the spouses and segregation of assets may be necessary prior to funding.

Spouses should not do SLAT’s for each other at the same time or in the same amount to avoid reciprocal trust issues.  If both spouses are eventually going to implement a SLAT for each other, there are a variety of differences that can and should be structured into each SLAT to render them non-reciprocal.

To the extent that income pays out to the spouse, all accumulations of that income will be included in and taxed as part of the spouse’s estate at passing.  Over time, depending on the age of the spouse and the amount of the income, this can result in significant increases in the taxable estate.  This is one of the reasons why smaller estates are less likely to benefit from a SLAT than larger estates.

A SLAT is by its very nature multi-generational.  A well crafted SLAT will utilize applicable GST exclusions, employ provisions to avoid the Rule Against Perpetuities, and build in succession and management tools for future generations when those alive today are all gone.

Is A Spousal Lifetime Access Trust Like a By-Pass Trust?

Because it uses the lifetime exclusion amount, it is accurate to say that a SLAT is similar to a by-pass or credit shelter trust.  However, there are some major differences.

• It is funded while living, rather than at death.
• Gifts to the SLAT are split between spouse and children or future beneficiaries.
• The value of future interests is NOT the same as the present market value.

For the declining number of states that still have a state estate tax, the SLAT can help mitigate the eventual liability.

Who Should Use A SLAT?

A SLAT is not for everyone.  Those who benefit the most will be married couples with combined estates well over their joint lifetime exclusion amounts.  Sometimes smaller estates will benefit based on state estate tax rates.  A SLAT should not be implemented in isolation from other planning.  To get the best results, it must be integrated with other trusts, business structures, and planning tools.  A SLAT is one of many tools that may or may not be appropriate in a given situation.

Because a SLAT is an irrevocable trust, and outside the estates of both spouses, it can provide significant asset protection as part of the estate plan.  Likewise, it works best when it incorporates powerful planning tools like a Trust Protector.

What is the Exit Strategy from a SLAT?

In reviewing many estate plans all over the country, I have encountered SLAT’s that are brilliantly implemented and that I cannot improve upon.  I have also found perfectly good SLAT’s that are mis-applied or that no longer fit the client’s needs and situations.  Sadly, I have also run into a few poorly thought out documents.  The most common deficiency I find in SLAT’s is that they work perfectly well while the spouse is living, but after that the Trust fails to protect the assets for future generations.  They lack what may be called “dynasty provisions” or other crucial tools that may be needed over time.

What do you do if you need to upgrade or get out of a SLAT?  There are a variety of ways to up-grade, transition or unwind a SLAT into better or other types of planning devices.  Such moves require careful planning, and a few conversations beyond the limited scope of this article.