by Cowles Liipfert and Don Wells

Spouses may make unlimited lifetime gifts to each other without gift tax, because of the US Gift Tax marital deduction.

For gift and estate tax planning purposes, gifts which qualify for the marital deduction do not provide as many estate and gift tax planning opportunities as some other tax strategies, such as Spousal Lifetime Access Trusts (SLATS), because marital deduction gifts become part of the taxable estate of the donee spouse and may be subject to estate tax at the death of the donee spouse.  A SLAT is not included in the taxable estate of the donee spouse.

In 2017, the federal gift and estate tax exclusions (hereinafter referred to as “exemptions”) were increased from $5 million to $10 million, adjusted for inflation.  In 2024, the $10 million amount is now up to $13.61 million, because of annual adjustments for inflation, but that exemption is scheduled to expire on 01/01/2026, at which time it will be cut in half under current law.  Also, Congress could change that law before its scheduled expiration date, or it could be extended to a later date (or even made permanent) by Congressional action.

The potential reduction of the exemption amount poses the following question:  What if you made a gift which qualified for the gift tax exemption at the time of the gift ($13.61 million in 2024) and at the time of your death, the estate tax exemption was a smaller amount?  Would the amount of the gift tax exemption used on the gift tax return, in excess of the estate tax exemption on the date of death, be taxed as part of your taxable estate on your federal estate tax return?

Let’s assume that you made taxable gifts totaling $12 million which were exempt from gift tax at the time of the gifts, and the estate tax exemption was $7 million on the date of death.  Would the $5 million difference be subject to federal estate tax at the time of death?

The Treasury Department has issued regulations to the effect that if the estate tax exemption is reduced after a gift when the gift tax exemption was higher, that the excess amount will not be “clawed back” into the donor’s taxable estate for estate tax purposes.  Treasury Regulations Sec. 20-2010-1(c).

Consequently, the $5 million in excess of the estate tax exemption under the above example would pass to the donees, free of both federal gift tax and estate tax.

What is a SLAT?

A SLAT is an irrevocable trust to which one spouse gives assets for the benefit of the other spouse, either as the sole beneficiary or as one of several beneficiaries, utilizing the donor’s lifetime gift tax exemption.  It can be like a “bypass” or “credit shelter” trust, except that those trusts are not created until after the death of the donor spouse, whereas a SLAT is created during his or her lifetime. 

The provisions of a SLAT agreement can vary and should be carefully drafted to achieve the donor’s objectives.  The beneficiaries can be the spouse, the donor’s children and grandchildren, or others, even someone outside the family.  The income does not necessarily have to be paid exclusively to the spouse for the spouse’s lifetime, since the gift will not qualify for the marital deduction.

Who should Consider Having a SLAT?

You should consider having a SLAT if you have a large estate which will probably be subject to federal estate tax and you would like to reduce your likely estate taxes by lifetime gifts. 

As Grantor of the trust, you would lose the income from the gifted assets, so you should retain sufficient lifetime income from other assets to support yourself.  But (a) income will presumably be paid to your spouse during his or her lifetime, and (b) your spouse would be free to use those distributions for your joint support and maintenance.

Can You or Your Spouse be the Trustee?

The Trust Grantor cannot be the Trustee of his or her SLAT.  The Grantor’s spouse can be the Trustee, but in that case he or she would not be allowed to make discretionary distributions to himself or herself, or to make certain other distributions.  The trust could have a qualified “distribution director”, but it would probably be better to have a corporate trustee or another qualified person or entity who would be deemed to be “independent,” to serve as Trustee.

What if the Donee Spouse Dies or You Get Divorced?

If the donee spouse predeceases the donor spouse, the donor would lose the indirect access of having the donee spouse use trust distributions for their joint support and welfare.  But the trust agreement could give the donee spouse a limited power of appointment, whereby he or she could name the donor spouse as a discretionary beneficiary of the trust.  

You could not name yourself as a beneficiary of a SLAT in the trust agreement, because that would be a retained interest, but if your spouse later named you as a discretionary beneficiary, that would not be an interest retained by you, and therefore it would be permissible for you to become a beneficiary in that manner.  Also, the SLAT agreement could allow you to borrow from the trust.

As to a possible divorce, the trust agreement could allow discretionary distributions to the donee spouse in the event of divorce, which the Trustee could exercise or not exercise, to fit the circumstances.

Who Pays Income Tax on SLAT income?

Often a SLAT is created as a “Grantor Trust” to require the Trust’s Grantor to pay income tax on trust’s income.  This allows the trust’s Grantor to further reduce his or her taxable estate without gift tax, but the trust agreement does not necessarily have to be drafted in that manner.  If the trust were not a Grantor Trust, the income distributed to beneficiaries would be taxable to them, and in that case, any undistributed income would be taxable on the fiduciary income tax return for the SLAT, at high fiduciary income tax rates.

Can You and Your Spouse Create SLATs for Each Other?

There is a “Reciprocal Trust Agreement Doctrine” which prohibits spouses from creating identical or nearly identical trusts for each other, but if your trusts are not too similar to each other, then each of you may have a SLAT.  If you want to have two SLATs, it is suggested that the two SLATs should have different trustees, some different beneficiaries, etc., to avoid the Reciprocal Trust Doctrine.

Conclusion

SLATs can be excellent tools for individuals with high net worth, liquidity and a stable marriage, especially if the federal estate tax exemption is not extended beyond December 31, 2025.  SLATs may present a unique opportunity to transfer assets to beneficiaries without federal gift or estate tax.

To consult with one of our firm’s attorneys, please call 336-725-2900.