Utilizing the Enhanced Lifetime Exemption with Spousal Lifetime Access Trusts

Completed transfers to Spousal Lifetime Access Trusts (SLATs) are gaining popularity in the tax planning community.  The TCJA doubled the basic exclusion amount and for 2021 the BEA is $11.7 million per individual or $23.4 million for married couples.[1]   Once the TCJA sunsets in 2026, the BEA will revert to an amount adjusted for inflation based on prior law, which is estimated to be slightly above $6 million per individual.  One of the most difficult modern estate planning situations is with a married client of moderate wealth, say $26 million, who has multiple children and about 25 years of life expectancy.  This client might express the sentiment, “What if I Need It?”  They are concerned that a completed gift to progeny might cause them to outlive their wealth, and place legatee(s) in an uncomfortable position requiring them to provide for the aging legator(s).  The temporarily increased BEA period provides a “use it or lose it” benefit that is available to a decedent who survives the period and use the higher BEA by completed gifts during the period.  This client may be a good candidate for a Spousal Lifetime Access Trust (SLAT), which is a type of trust capable of achieving their objectives of transferring wealth outside of their taxable estate, allowing those monies to grow estate tax-free, meanwhile retaining the ability to access it under certain predefined conditions.

Key Elements of a SLAT Trust

A SLAT provides for a transfer in trust to the spouse of the grantor which fails to qualify for the federal gift tax marital deduction.  The marital deduction generally allows for unlimited transfers to spouses.  One of the most common ways to fail to qualify for the marital deduction is the prevent the spouse from receiving unfettered rights to the income of the trust.  One technique is to grant the spouse a special power of appointment over the income or principal of the trust.  This provision needs to be handled with care by the drafting counsel, to protect the validity of the trust, maintain creditor protections, and preserve the intent of the grantor.

All trusts have the option of incorporating a trust protector.  A trust protector is an independent (non-adverse) third party or institution with the authority to perform certain duties stipulated by the trust agreement.  At a high level, they ensure the trust is fulfilling its intent, and are given certain powers to effectuate change if needed.  They are typically granted powers such as:[2]

  • Removing and replacing trustees,
  • Settling disputes among co-trustees, or between trustees and beneficiaries,
  • Altering trust provisions due to changes in the economy or tax laws,
  • Terminating the trust entirely,
  • Modifying the powers of trustees,
  • Correcting ambiguities or errors made when the trust was drafted.

Securing the Lifestyle of the Grantor

For some clients, the most important provision of a SLAT is to provide recourse in the event there is material deterioration in the grantor’s wealth.  The practical solution within the SLAT plan is to grant a non-adverse party, such as the trust protector, the right to add beneficiaries from a defined group to the trust.[3]  The defined group to effectuate this recourse is the descendants of grantor’s grandparents (which obviously includes the grantor themselves).  There is an element of legal risk with this trust provision, and legal risks are best handled prospectively with the drafting skills of experienced counsel.

Another drafting alternative to mitigate a foreseeable medium-term decline in wealth is to provide for loans of trust principal to the grantor’s spouse.  This loan, established using prevailing Applicable Federal Rates (AFR), can help the legator weather an economic storm without much change to their estate plan.  The interest paid and received could be disregarded completely if the trust maintains grantor trust status for income tax purposes.

Lastly, counter intuitive as it may seem, SLATs are not limited to married individuals.  Single grantors can use the same basic elements of a SLAT in a gifting trust to confer benefits to another family member or significant other.  This planning can be a bit less complicated considering the estate planner does not have to provide for marital deduction planning and spousal creditor issues.

Conclusion

Utilizing the higher BEA for clients with estimated estate values in the ballpark of $12-18 million per individual can be challenging and very fact sensitive.  Now, parlay this initiative with the global macro view of high financial asset valuations, economic contraction, and an impending liquidity trap at the federal reserve.  These broader economic uncertainties should not prevent these types of clients from utilizing the full amount of lifetime exemptions allowable under current law.  A SLAT is an excellent option to maximize flexibility in the current environment which helps clients assuage their troubles as they pertain to gift and estate tax issues.

 

[1] Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2021.” Accessed Mar 8, 2020.

[2] ElderLawAnswers. “What Is a Trust Protector and When Might You Need One?” https://www.elderlawanswers.com/what-is-a-trust-protector-and-when-might-you-need-one-7848. Accessed Mar 16, 2020.

[3] Shenkman, Martin M. “Spousal Lifetime Access Trusts (“SLATs”): A Key Planning Tool.” https://shenkmanlaw.com/uploads/2017/08/SLAT-3-Slides-Per-Page-webinar-Jul-15-2017.pdf. Accessed Mar 16, 2021.

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