I Want an Estate Tax Problem! SLATs
If you have succeeded in your gathering and protection of assets, you just may have a Federal Estate Tax problem. Consider a SLAT. How about that for a new financial goal: I want to have an estate tax problem!
Worried about Estate Taxes? Consider a SLAT
What is a SLAT used for estate planning? Are you worried about estate taxes, or do you think the exemption amount will go down?
Currently, you can have more than $11.7M in your estate before you pay estate taxes, but talk on the town is that number might decrease. By a lot! Right now, it may be an opportunity to consider a SLAT.
Let’s define SLATs, determine what they can be used for, and discuss the advantages and disadvantages of a SLAT for estate planning.
SLAT Trust Meaning, SLAT Definition
What is a SLAT Trust? First, the “T” stands for trust, so a SLAT Trust is a bit redundant. The meaning of SLAT is “Spousal Lifetime Access Trust.”
The definition of a SLAT is an irrevocable gift from one spouse to the other for their benefit. Since it is an irrevocable gift, it uses up the current estate tax exemption.
The idea is to use your $11.7M estate tax exemption now before they go and decrease it. If it is lowered in the future, you will have already used up the higher exemption, so you have no exemption left over. Fundamentally, it is a way to make sure estate taxes do not hit you if the exemption decreases in the future.
Each spouse can use their $11.7M estate tax exemption through SLATs, which means you can tuck away $23.4M and change free from estate taxes. This is also an “estate freeze” technique, which means all future growth of the assets in a SLAT occurs outside of the estate.
SLAT trusts are similar to bypass or credit shelter trusts, though those trusts are funded at death, whereas SLATs are gifts and funded while alive.
Aside from irrevocable, a critical point about a SLAT is that it is meant to avoid the unlimited gift tax marital deduction. Instead of “giving” your assets to your spouse at death (the amount of intra-spouse transfer is unlimited; the estate tax is portable from one spouse to the other), you force the use of your estate tax exemption before your death. I hope you understand that point!
The spouse receiving the SLAT can benefit from the trust’s income, but it is not “theirs,” so it is not included in their estate for tax purposes. Therefore, you have already “utilized” the estate tax exemption. There are also some excellent asset protection features which will be discussed below.
What can a SLAT be used for?
What Can a SLAT be Used For?
A SLAT can be used by a married couple who want to take advantage of their estate tax exemption now while it is still high.
If you fear the estate tax exemption will be decreased to $5M or $3.5M, then a couple can each use the exemption in current law. The goal of a SLAT is to use up that higher exception now, so they get “credit” for it even if they die in the future when the exemption is smaller.
Thus, a SLAT is sometimes used to avoid paying estate taxes. This is an especially powerful technique if you have more than $23M, but it may be appropriate for some with $11M who want to utilize a single spouse’s exemption amount. This may be true if one of the spouses is expected to have a short life than the other.
There is also a business use case discussed below.
It is important to note that there are no Claw Backs for Estate Taxes, so if you utilize your exemption now, you should be good to go even if it decreases.
No Claw Back for SLATs
Even if the estate tax exemption is decreased in the future, there is no “clawback” of your utilized estate tax exemption. That is, you don’t “owe” $6M or more in estate taxes if you use your $11M now and the estate tax exclusion is decreased to $5M in the future.
Of course, tax law is written in pencil, but this would be a truly evil change to make in the future. Let’s talk more about the current taxation of SLATs.
Taxation of SLATs
A SLAT is a grantor trust, which means the donor pays the taxes on the SLAT. This is good, as the federal income taxes are compressed for trusts (so you don’t want trusts paying taxes when an individual can).
Specifically, individuals have more room to recognize income in at lower marginal tax rates before they hit the highest marginal tax rate. In contrast, trusts hit the highest marginal tax rates at much lower income levels.
So, when you sign on the line for a SLAT, your spouse may get the income if they wish, but you continue to pay the taxes on the assets in the trust! This helps as an estate freeze technique and allows the money to grow larger outside the estate rather than within the estate (where estate taxes may be owed).
In addition, you don’t want “leakage” of the trust. If you pull money out and then put it in your estate (or, heaven forbid, a joint account!), then the money is included back in your estate for estate tax purposes. If the purpose of a SLAT is to utilize the Estate Tax Exemption amount, be careful pulling assets back into the estate, which may be double taxed (for estate tax purposes).
Another use case for a SLAT: is asset protection. Let’s look at that now.
Asset Protection of a SLAT
SLATs also provide asset protection, as the assets are held in an irrevocable trust. Specifically, the donor has no access to the trust and usually cannot be forced to access the assets in the trust. I shouldn’t go overboard, as if the initial funding (conveyance) is deemed fraudulent, a judge might access the assets within the trust on behalf of the creditors.
But as long as this trust is set up well before any creditor problems, it can be an important part of asset protection system.
Also, the SLAT likely has spendthrift provisions which do not allow the spouse who receives the SLAT to access it to pay off a judgment. In English, a creditor does not have the authority to force you to access trust assets to pay your judgments. However, if there is ongoing income from the SLAT, a creditor may lay claim to that income as it rolls in.
Laws are State-specific, so discuss SLATs and asset protection with your estate attorney in your State. Assets should also be protected in the case of divorce as long as they are not co-mingled in the marital estate.
Now that we know a little bit about SLATs let’s go over the pros and cons.
Pros and Cons of a SLAT
Pros of a SLAT
- Utilize current estate tax exemption and growth while in the SLAT is outside of the estate
- Asset Protection
- Income for the spouse and other beneficiaries or access to the principle
- Taxed to the donor
- SLATs are relatively simple, low-cost trusts and are mostly quite easy to understand
Cons of a SLAT
- Irrevocable, difficult to change terms once established
- Grantor Trust, which may require an Independent Trustee for discretionary distributions
- No Step-up in basis at death
- In divorce, you continue to pay the taxes as your spouse benefits from the income, or worse
- Need to have additional income outside the SLATs
- Reciprocal Trust Doctrine issues
Reciprocal Trust Doctrine
Avoid the “reciprocal trust doctrine.” This is very important, as if you create two identical trusts, they may be disallowed. The IRS might find that the trust for your spouse is actually for your benefit; thus, the amount will be included in your estate for estate tax purposes.
Here are some ways to keep the trusts non-identical:
- Fund with different types of assets
- Fund with different amounts
- Create and fund at different times
- Use different trustees with different powers
- Have different beneficiaries of the SLAT
- Establish the trusts in different states
- Set up different terms for distributions (one may have generous access to income or principle, while the other is limited in distributions)
Example of a SLAT Use Case
A couple has $25M of mixed assets. They set up SLATs for each other (careful to avoid the reciprocal trust doctrine) and get $22M out of their estate. Each has different trustees, different assets, and different disbursements, and the trusts were funded in different years and have different beneficiaries.
They plan to live on the income of one of the trusts and utilize the assets outside of the SLATs for their retirement. The SLATs pass on to their children and grandchildren when they die, and the rest of their estate is left to charity.
Other Important SLAT Considerations
Risk of Death or Divorce
When setting up the SLAT, you must consider the death of the non-donor spouse and its impact on the donor spouse. Once the beneficiary dies, the donor spouse no longer has indirect access to the trust.
Divorce may be even more devastating, as again, the donor may lose indirect access to the trust yet be expected to continue to pay the trust’s taxes!
The trustee of a SLAT is an important selection. The donor should not be a trustee, but the non-donor spouse often is a good selection as long as their power of distribution is limited.
Loss of Step-Up of Basis upon Death
As a SLAT is irrevocable, the assets in the SLAT do not receive a step-up in basis at death.
The Estate Tax is 40% in most cases, so you need to consider the tax implications of the loss of step-up in basis of the trust’s assets.
SLAT Assets and Community Property
SLATs can only have the assets of the donor spouse. Take care in community property states as most assets obtained during marriage are considered community property.
Who is the Beneficiary of a SLAT Trust?
Your spouse is the beneficiary of a SLAT. Your children or other descendants, or charity, may also be named.
Of course, if your goal is charitable giving, it may be useful to give while you are alive and reduce the taxable amount of your estate outside of a SLAT. The trustee has the power or discretion to distribute the trust’s income among the beneficiaries, as outlined in the trust document.
Usually, children become the trust beneficiaries upon the spouse’s death, but grandchildren may also be beneficiaries. Or, you can leave it to your spouse to assign beneficiaries of their SLAT.
There may be generation-skipping transfer tax issues, but that is beyond the scope of this document.
Other Ways to Leverage SLATs
SLATs can be used to purchase life insurance, even with yearly (Crummy) gift donations. In addition, valuation discounts are possible when considering LLCs and partnerships.
Limitations of a SLAT
You may only gift (irrevocable) assets, not yours and your spouses. Thus things like joint bank accounts cannot be given to a SLAT.
Community property states complicate the mix, as most assets acquired during the marriage are community assets.
In addition, distributions cannot go to joint accounts; they should only go to the beneficiaries’ accounts.
What Are the Advantages of Creating a SLAT?
SLATs take advantage of the estate tax exemption during your lifetime. The goal is to use the exemption before it is reduced in the future.
As mentioned above, SLATs may also be used for asset protection.
SLAT may also be combined with ILITs (Irrevocable Life Insurance Trusts), dynasty trusts for the grandchildren, and even a credit shelter trust if there is any remaining estate tax exemption.
Business Use of a SLAT
SLATs may also be used for family businesses, especially those expected to increase in value. You can use a SLAT to fill up the estate tax exemption, and any future asset growth occurs outside of the estate.
State Estate Taxes
SLATs may also be funded to take advantage of State estate taxes. Check out your State to see if there is a state estate tax.
For most states, while there may be a state estate tax, there is no state gift tax, so you can fund these trusts and get them out of your estate before death. Since they are not part of your estate at death, state estate taxes are not levied.
Again, this is a state-by-state issue so discuss it carefully with your estate attorney. There may be an opportunity to escape state estate taxes even if you are not worried about federal estate taxes.
Summary – a SLAT – I want an Estate Tax Problem
In summary, a SLAT is an effective tool for estate planning when you are worried about estate taxes. Utilizing your current estate tax exemption, you can provide your spouse access to income for life, all while providing asset protection and even a dynasty-type trust.
SLATs are flexible, have business use cases and state estate tax considerations, and can be used if one spouse has a shorter expected life span than the other.
There are many advantages to SLATs, but an obvious disadvantage is the irrevocable nature of the SLAT.
All in all, SLATs are an effective way to utilize the massive estate tax exemption NOW before it shrinks in the future. So if you plan to avoid estate taxes, you might do so.
Finally, if you want to optimize your estate plan, you want to know about qualified disclaimer estate planning.