A spousal lifetime access trust (SLAT) is an irrevocable trust that one spouse (donor spouse) creates during their lifetime for the benefit of the other spouse (beneficiary spouse). The donor spouse makes a completed gift into the trust, using their federal gift and estate tax exemption. SLATs are structured so as not to be counted in the beneficiary spouse’s taxable estate.

How a SLAT Works

The exemption in 2023 is $10 million indexed for inflation ($12,920,000 per individual) and, absent a change in the law, will reduce to $5 million (indexed) beginning January 1, 2026. To capture what may be a temporarily higher exemption, a SLAT is designed to use the donor spouse’s exemption before the amount may change. As a completed gift, it also has the benefit of protecting future (postgift) appreciation from estate tax inclusion.

Further, there is an option to structure and allocate the donor spouse’s generation-skipping transfer tax exemption to the trust, which allows the trust to benefit multiple generations without being subject to transfer tax until the SLAT ultimately terminates.

Distributions to a beneficiary could be mandatory (e.g., all income), but it is tax-efficient not to do so and instead make distributions at the discretion of the trustee. Although tax law does not allow the donor spouse to serve as trustee, the beneficiary spouse can be appointed as trustee or co-trustee. To do so and still achieve the intended estate tax treatment, tax law requires, among other things, any beneficiary serving as trustee to have limited discretionary authority over distributions. Their power must be limited to no more than what is known as the ascertainable standard. This means they cannot vote to distribute assets for any purpose beyond health, education, maintenance or support. Of course, the trust can be drafted to limit the authority to even less.

Planning for Taxes

A SLAT is a grantor trust under the IRS’s grantor trust rules, meaning the donor spouse bears the ongoing income tax burden of the SLAT. Although this sounds like a detriment, it can be tax efficient for two reasons:

• This grantor trust status permits the assets of the SLAT to accumulate within the trust without being reduced by payment of income taxes.
• By paying the tax obligation with assets outside the trust, the donor’s yet-to-be-subject-to-estate-tax assets are reduced. In a sense, this provides a discount on the income tax obligation to the extent that the assets otherwise would have been subject to estate tax.

Only a few states still have estate or inheritance taxes. Those that do often do not follow the federal rules, but in most cases a properly drafted SLAT can remove assets from both the federal and state taxable estates.

Planning for Potential Challenges

A SLAT should be carefully drafted to maintain the integrity of the trust and effectively remove SLAT assets from both the donor spouse’s and the beneficiary spouse’s estates. While the SLAT as a concept appears innocuous, in reality there are numerous hidden tax traps, including:

• Any evidence of an agreement or pre-arrangement with the donor spouse to use distributions from the trust for the benefit of the donor spouse can defeat the purposes of the SLAT by causing inclusion of the trust assets in the taxable estate of the donor spouse.
• If SLAT assets are or can be used to satisfy a donor spouse’s legal obligation of support or to relieve the donor spouse of debt, inclusion will result.
• The same adverse result occurs if an agreement exists to exercise a limited power of appointment in favor of the donor spouse at the death of the beneficiary spouse.

Another issue is what is known in tax jargon as the reciprocal trust doctrine. In the SLAT context, it arises when married clients seek to each create a SLAT for the benefit of the other. Estates of spouses who each create SLATs for the benefit of the other might be challenged by the IRS to demonstrate that the reciprocal trust doctrine does not apply, namely:

• The facts and circumstances surrounding the creation of the estate plan must indicate it has substance (i.e., serves a purpose beyond removing assets from the spouses’ estates).
• After creating the trusts, the spouses are not in substantially the same economic position if they had either not created trusts or had created trusts naming themselves as beneficiaries.

Examples of common approaches attorneys use to navigate the reciprocal trust doctrine are to create the SLATs at different points in time, fund with different amounts and assets of varying character, have contrasting dispositive provisions (perhaps by different current or remainder beneficiaries), have one SLAT confer a special or limited power of appointment onto the beneficiary spouse but the other SLAT does not, and name different initial and successor trustees who are authorized to exercise disparate powers under the trusts.

Planning for Contingencies

The SLAT should be drafted to anticipate contingencies such as death or divorce and direct trustees accordingly. For example, a SLAT may provide that the filing of a divorce complaint or a cessation in cohabitation between spouses serves to remove a spouse’s beneficial interest in the trust and replace it with that of a remainder beneficiary. Another provision sometimes used is for the donor spouse to name the current spouse as beneficiary at the time of a distribution. Thus, it allows a later spouse to step into the shoes of an originally named spouse beneficiary (in case of death or divorce).

The donor spouse should be prepared not to have access to SLAT assets upon the death of the beneficiary spouse. If the assets were to be needed, then a SLAT may not be the right tool. If it is a close call, options may include buying life insurance or, in some cases, providing the beneficiary spouse a precise right to direct the distribution of the remaining trust assets at the beneficiary’s death among a group of potential beneficiaries other than the donor spouse. Such a power must be precisely crafted and carefully exercised so estate tax inclusion does not occur. For example, in many states, if the will of the beneficiary spouse appoints the property to or for the donor spouse, it will be subject under state law to the donor spouse’s creditors, which causes federal estate tax inclusion in the estate of the donor spouse.

Conclusion

SLATs can bring potential significant long-term tax savings to a family by avoiding estate tax inclusion. Risk of inclusion exists when a SLAT is not carefully crafted or when administrative requirements are not met. Spouses who each implement this technique for the benefit of the other should plan carefully that the SLATs they create will not run afoul of the reciprocal trust doctrine. Consult with your attorney and other members of your financial team to model and create a SLAT that can work for you.

To learn more, contact your Glenmede Wealth Advisor or visit us at Glenmede.com.