Spousal Lifetime Access Trusts (SLATs): Benefits, Risks, and How They Work

Key Takeaways

• The looming sunset of elevated estate and gift tax exemptions at the end of 2025 has increased interest in SLATs, but it is important to act before the potential changes take effect.
• It’s critical to carefully consider the complexities of SLATs before implementation.

The clock is ticking on a significant tax advantage. In 2026, the current Federal estate and gift tax exemption, an unprecedented $13.61 million per person or $27.22 million per couple, will be sharply reduced unless Congress acts.

One strategic tool many high-net-worth couples are increasingly leveraging before the exemption sunsets is a Spousal Lifetime Access Trust (SLAT). SLATs offer a way to benefit spouses while strategically removing assets from taxable estates. If structured properly, SLATs can provide creditor and estate tax protection for generations to come.

In this article, we examine the mechanics of SLATs and the key considerations when deciding if this strategy aligns with your estate planning goals.

How Does a Spousal Lifetime Access Trust Work?

Here’s a breakdown of the key steps involved in establishing and utilizing a SLAT:

1.   Creation and Funding

The donor spouse creates a SLAT and contributes individually held assets for the benefit of the donee spouse. These gifts are then reported on the donor’s gift tax return, applying the grantor’s Federal gift tax exemption.

2.   Beneficiary Access

Once funded, the SLAT may make distributions to the beneficiary spouse. While the donor spouse can’t directly receive distributions, they may indirectly benefit from the funds their spouse receives.

3.   Distribution Upon Termination

The SLAT may terminate upon the beneficiary spouse’s death but more commonly continue in trusts for the benefit of the couple’s children and more remote descendants, providing both creditor and estate tax protection for generations.

“Use it or Lose it”

The Tax Cuts and Jobs Act of 2017 significantly increased estate and gift tax exemptions, allowing individuals to transfer up to $13.61 million tax-free in 2024. These elevated exemptions are set to sunset at the end of 2025, reverting to pre-2018 levels without Congressional action.

This looming change has motivated many couples to explore strategies like SLATs to leverage these historically unprecedented exemptions before they expire. In response to concerns that acting now may cause later tax consequences, the IRS implemented an “anti-clawback” rule to protect gifts made during this high-exemption period, even if the exemptions decrease in the future.

The Reciprocal Trust Doctrine

Typically, when utilizing this estate planning strategy, each spouse creates a SLAT for the benefit of the other, allowing both to maximize the use of the elevated tax exemptions. However, the IRS closely scrutinizes mutual SLATs under the Reciprocal Trust Doctrine. This doctrine essentially untangles trusts that are too similar, treating each spouse as if they created a trust for themselves, which negates tax benefits.

In properly planning with SLATs, it is critical to differentiate the trusts in terms of assets, trustee powers, and beneficiary interests to avoid triggering the Reciprocal Trust Doctrine. Additionally, creating and funding each trust at different times, ideally in separate tax years, adds another layer of distinction. Separating these assets well in advance is recommended for couples with jointly owned assets intended for SLAT funding.

Income Tax Considerations

SLATs are classified as “grantor trusts” for income tax purposes. This means the grantor, not the trust, is responsible for any income or capital gains taxes generated by the trust assets. While this could seem like a drawback, it actually presents a unique advantage. Since the trust’s assets grow tax-free, the grantor is essentially making additional tax-free gifts to the trust each year.

It’s crucial to draft SLATs carefully, particularly with divorce in mind. As a grantor could lose access to the spousal SLAT assets in a divorce and still be liable for the taxes on those assets. Proper planning can help mitigate these risks.

Are There Potential Drawbacks of SLATs?

While SLATs offer significant benefits in estate planning, they come with potential drawbacks that should be carefully considered before implementation:

• Loss of Control: The grantor spouse irrevocably gives up control over the assets transferred to the SLAT.
• Loss of Access upon Spouse’s Death/Divorce: If the beneficiary spouse dies before the grantor or the two get divorced, the grantor loses indirect access to the trust assets. This could create financial hardship if a grantor relies on those assets.
• No Step-up in Basis: Assets in the SLAT do not receive a step-up in basis upon the grantor’s death.
• Complexity: Setting up and administering a SLAT can be complex, requiring the involvement of experienced legal and financial professionals.

Final Thoughts

SLATs are powerful estate planning vehicles, offering flexibility and significant tax benefits, especially in the current high-exemption environment. If you’re considering a SLAT, consulting with an experienced estate planning attorney is highly recommended to help guide you through the complexities and tailor a plan that aligns with your family’s unique goals and circumstances.

Disclaimer: This article is made available by Sterlington for informational purposes only. It is not intended to provide specific legal advice and should not be used as a substitute for competent legal advice from a licensed professional attorney in your state. Using this website does not establish any attorney-client relationship between Sterlington and yourself.