Estate Planning? The Benefits and Pitfalls of Gifts to SLATs
With the looming sunset of the Tax Cuts and Jobs Act of 2017, Spousal Lifetime Access Trusts (SLATs) have become a very popular estate planning tool for high-net-worth taxpayers.
By Sarah Johnson, CPA, and Joanie Sompayrac, CPA, MAcc, JD | Digital Exclusive – 2024
Taxpayers typically view estate planning as a relatively straightforward process: Find an estate planning lawyer, write a will, choose an executor, and ensure their assets are properly titled so that the process will go smoothly for any surviving family members or beneficiaries. However, with the looming sunset of the Tax Cuts and Jobs Act of 2017 (TCJA), estate planning is anything but straightforward.
Taking Advantage of Exemption Amounts
The estate tax exemption amount is the dollar amount a taxpayer can give away before they must pay estate tax on their assets, and this amount has increased steadily from $1 million in 2002 to $13.61 million in 2024. This is in large part due to the TCJA, which more than doubled the estate tax exemption amount from $5.49 million per taxpayer in 2017 to $11.18 million in 2018. Since then, the exemption amount has been indexed for inflation and currently sits at $13.61 million per taxpayer.
While the IRS has tried to assure taxpayers that the agency won’t try to “claw back” high-dollar gifts to estates, taking advantage of the current exemption amounts before they sunset on Jan. 1, 2026, is advised due to the uncertainty of what will happen thereafter.
The Rise of SLATs
In 2012, when the estate exemption was set to drop from $5.12 million to $1 million, the Spousal Lifetime Access Trust (SLAT) rose in popularity as an estate planning tool. Now, with the TCJA’s looming sunset utilizing SLATs is trending once again.
Though there are variations on how they’re structured, a SLAT is typically set up as an irrevocable but intentionally defective grantor trust with the grantor’s spouse and descendants named as beneficiaries. The grantor makes a gift of individually owned assets to fund the trust while the grantor is still living. Any income earned by trust assets is reported on the grantor’s individual tax return. The trust is able to be treated as a grantor trust for income tax purposes. Meanwhile, the assets in the trust can appreciate outside the gross estate because they’ve been irrevocably transferred into the trust, thus keeping the trust property out of both the taxable gross estate as well as the probate estate.
Why a SLAT?
From an estate planning perspective, one can see why SLATs might make an attractive vehicle for wealth transfer—they allow a grantor the chance to direct where assets go and how they’ll be used both presently and potentially years into the future.
For example, if a grantor transfers cash or property outright to children and grandchildren, they can do virtually anything with it. However, if the grantor transfers assets in a trust with a written trust agreement and assigns a trustee who can only spend the trust assets in accordance with the trust agreement, then the grantor can have confidence that the trust assets will be used as they wish.
There are many reasons a person would want to guide how assets are distributed to future generations. Perhaps a family member is irresponsible with money or has substance abuse problems. Sometimes parents want to provide for a child or their grandchildren despite distaste for the child’s spouse or significant other. Others simply want to make sure descendants have their educational and/or medical expenses underwritten. Therefore, lifetime gifts to trusts are a paradoxical way to control what happens to a grantor’s assets after death by relinquishing control of them during life.
Gifts to a SLAT can also be used to simplify the estate administration process and avoid a lengthy and expensive probate process. By signing assets over to a trust during life, a decedent can save survivors the time-consuming headache of probating an estate during the grieving process. Additionally, if the assets are held in a trust, the grantor’s death won’t interrupt access to the assets. A gift to a trust is a private matter, but probate records are available to the public. Many high-net-worth individuals value the privacy that trust gifts create for their family.
Lastly, and most relevant to the topic at hand, gifting to trusts can be an excellent strategy to mitigate estate and generation skipping transfer taxes. When an asset is transferred into an irrevocable trust, the fair market value at the date of gift essentially freezes the asset’s value in time. Assets transferred into a trust can generally appreciate in value over time, but once they are placed in an irrevocable trust, the trust assets are no longer included in the taxable gross estate. The value of the taxable gift is factored in when calculating the potential estate tax, but theoretically, it’ll be at a much lower date-of-transfer value instead of the date-of-death value.
What Are the Risks?
Although the primary goal of a SLAT is to preserve the assets in the trust and allow them to appreciate, setting up the spouse as the trust beneficiary is a way for the household to still have the safety net of access to both the income generated by the assets and the assets themselves in case of emergency.
However, to avoid inclusion in the gross estate, care must be taken when distributions are made to the beneficiary spouse. If distributions are made to a joint account rather than just to the beneficiary, it could cause the SLAT to be brought back into the grantor’s estate, according to IRC §2036(a).
There are several other potential pitfalls to be aware of. For starters, many estate planners find themselves in the involuntary position of serving as a family therapist as their clients reveal skeletons in the closet, family drama, and strained relationships during planning conversations. Notably, the absolute worst time to fund a SLAT is when a couple is having marital problems. A SLAT is a fantastic estate planning technique for people who are securely and happily married. However, in the event of a divorce, the worst-case scenario can happen where the grantor spouse is left paying tax on the income of the SLAT while the beneficiary spouse effectively gets to keep all the assets in the trust for their benefit with no income or estate tax consequences. To mitigate risks associated with divorce, estate planners should carefully draft a trust agreement and consider including language that the beneficiary spouse ceases to be a beneficiary in the case of divorce.
Another potential risk can arise if the grantor has put a large portion of the grantor’s assets into a SLAT for the benefit of the grantor’s spouse and the spouse dies unexpectedly. At this point, the SLAT would typically pass to the grantor’s children or the other beneficiaries. However, if family relationships are strained, and the deceased spouse’s assets passing to the surviving spouse are limited, this scenario can lead to a grantor being left with few resources and no safety net. This is why the types of assets placed in a SLAT need to be carefully considered. Are the SLAT assets something the surviving grantor spouse can live without indirect access to if the beneficiary spouse dies prematurely? If not, then the grantor should reconsider transferring all of these assets irrevocably to the SLAT.
One way to overcome the risk that comes from this lack of access to assets upon a beneficiary spouse’s premature death is for each spouse to fund a SLAT for the other’s benefit. Not only does this method mitigate financial risk, but it also allows for each spouse to lock in the higher level of estate exemption prior to the TCJA sunset. Each SLAT, however, will need to have differing terms to ensure there’s no violation of the reciprocal trust doctrine. The central point of the reciprocal trust doctrine is that two people can’t set up identical trusts for each other’s benefit and still get to exclude the trust assets from their estates.
When attorneys are drafting SLAT agreements for both spouses, there are many differences they can include in the trust agreements as a safety mechanism to avoid violating the reciprocal trust doctrine. The two trusts should ideally be set up and funded in different calendar years and have at least several differences, such as different groups of beneficiaries, types and dollar values of assets, powers of appointment, trustees, and distribution standards, to name a few.
Special Care and Attention
As previously stated, care must be taken when deciding what assets to transfer to a SLAT. For many taxpayers, the best properties to consider are stocks and bonds that are likely to appreciate, life insurance policies, real estate, and alternative investments (such as a closely held business property or intellectual property). These items must be valued per gift tax return instructions. This will likely involve getting qualified appraisals done on real estate, partnership interests, and other closely held business entities.
Remember, gifts to SLATs are irrevocable, and if a grantor needs guaranteed ongoing access to an asset, they shouldn’t gift it. For this reason, putting a primary residence into a SLAT is possible but not recommended. Retirement plan assets should also not be gifted to a SLAT, as this creates a deemed distribution of the assets.
Thought should also be given to the cost of administering the SLAT’s assets. This is particularly relevant with gifts of real estate. If money spent on maintaining the assets doesn’t come from the trust itself, it’s an additional “gift” that can create gift tax consequences.
While the primary goal of the SLAT is to allow assets to appreciate outside the estate, this comes with the drawback that trust assets aren’t given a step-up in basis upon the death of the grantor. This drawback can be mitigated by including certain language in the trust agreement that allows the grantor to switch out assets. This may seem counter-intuitive, but the grantor trust laws under IRC §675(4)(c) allow “a power to reacquire the trust corpus by substituting other property of an equivalent value.” If a grantor is elderly and in poor health, that grantor can remove highly appreciated assets from the trust and substitute cash or unappreciated assets of equivalent value. Consequently, when that grantor dies, the same total amount of money is excluded from the grantor’s estate, but the appreciated assets will get a step-up in basis.
Given the current level of uncertainty surrounding the estate tax exemption amounts and proposed changes in the estate tax system in general, thoughtfully crafted SLATs offer an excellent tool for high-net-worth taxpayers. Despite some of the risks they carry, SLATs are still one of the best ways currently available to shield millions of dollars of assets from estate tax.
Sarah Johnson, CPA, is a tax manager at LBMC. Joanie Sompayrac, CPA, MAcc, JD, is the Judith Finley Stone Alliance Professor of Accounting at the University of Tennessee at Chattanooga.
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