November 01, 2016

Spousal Lifetime Access Trusts

Jay A. Soled

For years leading up to 2013, spousal lifetime access trusts (SLATs) were in vogue. Why? They provided an opportunity for married taxpayers to make full use of their federal transfer tax exemption amount before it was scheduled to decline from $5 million to $1 million. At the time, the psychology of “use it or lose it” was pervasive. Notwithstanding the threat of the exemption declining, for tax years beginning in 2013, Congress permanently made the federal exemption amount $5 million (adjusted annually for inflation). Going forward, the salient question is whether SLAT use is still a viable estate planning tool.

By way of background, a SLAT is like many trusts established for estate planning purposes. It is inter vivos (i.e., set up during life) and irrevocable. One spouse is supposed to fund it with cash or property equal to the federal transfer tax exemption amount. The trustee (usually, the other spouse) can then use this reservoir of assets for his or her lifetime benefit and upon his or her demise, the then value of the trust assets should not be includable in the estate.

Even though the federal transfer tax exemption amount is now firmly established, there are at least three reasons SLATs remain a viable tool in the estate planner’s quiver.

First, SLATs can be an effective strategy used to defeat state estate taxes. Consider the fact that many states still retain a state estate tax and, in some instances, with exemption amounts that are far lower than that of the federal government (e.g., in New Jersey, the estate tax exemption amount is currently $675,000). The vast majority of these states do not have a gift tax. That being the case, taxpayers in those states that have retained a state estate tax can fund a SLAT, and the funds it holds and whatever they grow to escape state estate tax.

Second, the use of SLATs can be an effective asset protection strategy. Assets that fund SLATs are generally protected from the reach of creditors. If properly drafted, this makes SLAT use particularly attractive because it permits the beneficiary spouse with the best of both worlds: beneficial trust access yet prophylactic creditor protection.

Third, if need be, by using SLATs taxpayers can more easily put their generation-skipping transfer tax exemptions to work. Under current law, every taxpayer has the ability to transfer an amount equal to federal transfer tax exemption (currently, $5,430,000) to so-called “skip persons” (generally, their grandchildren and more distant descendants) by making what is known as a generation-skipping transfer (GST) tax exemption allocation. Under current law, the federal transfer exemption is portable upon death between spouses; the same is not true regarding the generation skipping transfer tax exemption. SLATs provide the opportunity to utilize the grantor spouse’s GST tax exemption without having to do so upon his or her demise.

Notwithstanding these virtues, SLAT use is not for all taxpayers. One possible shortcoming of SLAT use is that the assets held in a SLAT are not includable in the beneficiary spouse’s estate. That being the case, the “tax basis is equal to fair market value” rule does not apply to the trust-held assets. This may leave appreciated trust assets with significant income tax exposure. Another possible problem is that if the married taxpayers subsequently divorce, assets contained in the SLAT are difficult to account for in terms of equitable distribution. Finally, if each spouse decides to establish a SLAT for the benefit of the other spouse, the IRS may try to invoke what is known as the “reciprocal trust doctrine” to challenge the legitimacy of one or both of the trusts for estate tax inclusion purposes.

SLATs use has not disappeared from the estate planning landscape. Nevertheless, those married taxpayers who decide to put SLATs to use must carefully weigh the advantages and disadvantages of utilizing this estate planning strategy.

Jay A. Soled

Jay A. Soled is a professor at Rutgers University in Newark and the editor of the SLD book, Estate Planning Strategies: A Lawyer’s Guide to Retirement and Lifetime Planning. The information in this article is intended as general information only and should not be acted upon without professional advice.