SLAT: Gift tax benefits for future planning
SLAT stands for Spousal Lifetime Asset Trust. It is an irrevocable trust created by one spouse to benefit the other as well as other beneficiaries. To form a SLAT, one spouse (the grantor) uses their assets to form a trust. The beneficiary of the trust is generally the other spouse during their lifetime. This is similar to a QTIP trust, except that it is formed while both spouses are alive. The grantor also names other beneficiaries for after the beneficiary spouse dies.
Funding and Structure
The assets used to fund the trust take advantage of the federal lifetime gift tax exemption. In 2020, that exemption is up to $11.58 million. Minnesota does not have a gift tax so there is no exemption. SLATS first became popular in 2012. Then the gift tax exemption was $5.12 million. Looming in 2013 was a fiscal cliff scheduled to drop the gift tax exemption to only $1 million. By setting up SLATs before the drop, couples could take advantage of the higher annual gift tax exclusion and avoid the implications of the changing legislation.
What the SLAT does is take money out of the estate for the grantor spouse. By removing the money from the estate, it can be used to avoid taxes. In 2020, the federal estate tax is $11.58 million, and the Minnesota estate tax is $3 million. The SLAT works very much like how a bypass trust works in an AB trust scheme. The key difference is that the SLAT forms an irrevocable trust during the life of the grantor. The bypass trust in the AB trust is “testamentary”, meaning it is not formed until after the grantor's death.
A second benefit to a SLAT is asset protection. Once the assets are placed in the irrevocable trust, they cannot be accessed by the beneficiary spouse's creditors. This is different than assets in a revocable trust, to which creditors can go after.
The SLAT has a great deal of flexibility. For example, a grantor can name other people (e.g., their children) as beneficiaries along with the spouse. It can allow distributions of income, income and some access to principle, or even income for a particular purpose. (The HEMS standard is common, meaning health, education, maintenance, and support.) The beneficiary spouse can even use a distribution to benefit the grantor spouse.
Considerations and Pitfalls
There are several considerations to be made when forming a SLAT:
Irrevocable Trust. The SLAT must be irrevocable. If it is revocable, then the assets remain in and are included in the grantor's estate. The grantor cannot be given a beneficial interest, or any power to replace the trustee with themselves.
Remainder beneficiaries. The beneficiaries after the beneficiary spouse dies can be anyone, including for example, children, grandchildren, or a charity. In this way the SLAT can be a dynasty trust, keeping assets in the family even if the beneficiary spouse remarries.
Wholly owned assets. The grantor needs to fund the SLAT with assets that they own outright. Assets jointly owned by both spouses cannot be used to fund the SLAT.
Income taxes. The SLAT is a separate entity that is earning income. Therefore, it needs to be registered with the IRS and must pay taxes on that income. One option with the SLAT is to turn it into a grantor trust. This means that the grantor spouse would continue to pay the income tax on the trust's income, without using the gift tax. This creates a tax-free ongoing gift to the beneficiary spouse.
One additional thing to look out for is called the Reciprocal Trust Doctrine. This doctrine applies if two spouses make reciprocal trusts that are nearly identical. In that case, the IRS can treat each trust as if the beneficiary spouse created the trust. This prevents the funds from taking advantage of the gift tax exclusion.
Takeaway
A Spousal Lifetime Asset Trust is an excellent way to set up a tax shelter for your estate and shelter assets from creditors. They must, however, be set up properly to avoid the various pitfalls that may prevent the assets from being removed from one's estate. But with careful drafting, the SLAT can be an effective tool for managing one's wealth. If you have questions about whether a SLAT may be appropriate for your estate plan, contact Signature Law for a free consultation.