WEALTH TIP OF THE MONTH

Spousal Lifetime Access Trusts (SLATs) 

The Good and the Bad 

 

 

As we approach 2025, Spousal Lifetime Access Trusts (SLATs) are poised to experience a significant surge in use. Initially gaining attention during the uncertain period leading up to the 2012 fiscal cliff, these trusts have evolved into a crucial tool for estate planning, particularly as clients anticipate the potential reduction of the federal estate tax exemption. 

 

The 2010 Tax Relief Act temporarily raised the federal estate and gift tax exemption to $5 million per individual, a notable increase from previous levels. However, as the fiscal cliff loomed in 2012, there was widespread concern that these higher exemptions could be reduced, sparking a wave of estate planning activities. During this time, SLATs became increasingly popular among estate planners who saw them as a way to secure the enhanced exemption. These trusts allowed one spouse to make significant gifts to a trust benefiting the other spouse while retaining some access to the assets. 

 

Today, taxpayers can transfer up to $13.61 million per individual, or $27.22 million for married couples, to beneficiaries without incurring gift and estate taxes. The top estate tax rate is currently 40% on amounts exceeding these exemptions, leading many to believe that the high exemption reduces the need for complex end-of-life tax planning. However, these elevated exemption levels are set to revert to pre-2017 levels in 2026, potentially lowering the exemption to approximately $5 million per individual plus cost of living. 

 

This impending reduction has created urgency among taxpayers, particularly those who are aware of proposals being put forth, like Elizabeth Warren's tax plan. This proposal could further reduce the estate tax exemption to $3.5 million per individual and impose higher tax rates on larger estates. Such changes would expand the range of estates subject to taxation, making proactive planning more critical than ever. As a result, many astute taxpayers are turning to SLATs to maximize the current exemption while it remains available, thereby locking in tax advantages before the anticipated changes take effect. 

 

SLATs function by allowing one spouse, referred to as the donor spouse, to transfer assets into an irrevocable trust for the benefit of the other spouse, the beneficiary spouse. This transfer utilizes the donor spouse's lifetime exclusion amount, effectively removing the assets from their taxable estate, including any future appreciation. The beneficiary spouse can access the trust's assets as needed, providing both flexibility and financial security. Meanwhile, the donor spouse retains indirect access to the assets through their marriage and has control over how the trust assets will be managed and distributed. Moreover, SLATs offer strong asset protection, as the trust structure can help shield assets from potential creditor claims. 

 

However, SLATs come with potential drawbacks that should be carefully considered. One of the primary risks is that of divorce or death. If the donor spouse and beneficiary spouse divorce, or if the beneficiary spouse predeceases the donor spouse, the donor risks losing access to the assets in the SLAT. To mitigate this risk, a "floating spouse" provision can be included in the trust, identifying the beneficiary as the "person to whom the settlor is currently married" rather than naming a specific individual. Additionally, the trust can be drafted to allow the trustee to make loans to the donor spouse for further protection. 
 

Unwanted tax consequences are another potential pitfall of SLATs. If the donor spouse retains certain powers over the trust, such as the unrestricted ability to replace the trustee, the SLAT's assets might be included in the donor spouse's estate, defeating the trust's tax avoidance goals.  

 

Contributions to a SLAT are also considered completed gifts, which means that if the contribution exceeds the annual gift tax exclusion ($18,000 in 2024), it will reduce the donor spouse's lifetime exclusion.  

 

Additionally, SLAT assets typically do not receive a "step up" in cost basis at either spouse's death, which can increase capital gains taxes for beneficiaries when the assets are eventually sold. 

 

Couples must further be cautious about creating reciprocal SLATs, as this could result in the trusts being "uncrossed" and thus included in each spouse's estate, undermining the primary purpose of the SLAT. Proper planning and careful drafting are essential to avoid this issue.  

 

In addition, under the Internal Revenue Code (IRC) § 2036, if an individual transfers assets but retains the right to income, possession, or enjoyment of the assets, or control over who will benefit from them, those assets will be included in their gross estate for estate tax purposes. This situation can occur when creating a SLAT, especially if one spouse gives assets to the other to fund a trust that names the wealthier spouse as a beneficiary. 

 

As the landscape of estate planning continues to evolve, the rise of SLATs will likely accelerate, making them an increasingly critical part of the conversation between clients and their advisors. Whether used to navigate the complexities of estate tax law or to ensure the financial well-being of future generations, SLATs are set to play a pivotal role in the years ahead. By utilizing the current high exemption amounts before they potentially decrease, individuals can establish trusts that remove assets from their taxable estate, ensuring that they make the most of the tax advantages available today. 
 

For further insights into the unique advantages of a SLAT and other tax planning options, feel free to reach out to us. 

barry.boscoe@brightonadvisory.com  

Office: 818-342-9950 

Mobile: 818-802-0686