The Tax Cuts and Jobs Act (TCJA) almost doubled the lifetime gift and estate tax exemption back in 2017. Unless Congress acts to change it, this inflation-adjusted exemption will return to its previous level in 2026, cutting the current exemption amount in half. This has spurred significant estate planning activity. One tool, the Spousal Lifetime Access Trust, or SLAT, has been the beneficiary of much attention. This guide provides an overview of how SLATs can potentially help high net worth couples navigate this changing tax landscape.
Please note: this article is intended to provide general information only. Always consult your tax and estate planning professional for advice and specific recommendations.
What Is A Spousal Lifetime Access Trust (SLAT)?
A Spousal Lifetime Access Trust (SLAT) is a trust set up by one spouse for the benefit of the other. The donor spouse places assets into the SLAT, and the beneficiary spouse can access these assets under certain conditions. This arrangement reduces the taxable estate of the donor spouse while maintaining access to the funds indirectly through the beneficiary spouse.
SLATs are a type of irrevocable trust, which means that once formed, they cannot (easily) be reversed. These trusts can hold various assets such as cash, real estate, and securities. They are a popular choice to help couples reduce estate taxes while retaining some benefits from the trust assets.
How A Spousal Lifetime Access Trust Works
In a Spousal Lifetime Access Trust (SLAT), one spouse, known as the donor, contributes various assets such as cash or stocks to the SLAT. They then record this on their gift tax return. In states with community property laws, like California or Texas, there might be a need to reclassify joint assets into individual ownership first.
After the SLAT is established, the other spouse, the beneficiary, can receive money or assets from the trust. The donor may also benefit indirectly from this. When the trust ends, usually upon the beneficiary’s death, any remaining assets in the trust are passed on to other named beneficiaries.
Here’s an example to illustrate how this might be used. Consider a theoretical married couple, Alex and Jordan, with a combined net worth of $28 million. If they each put $10 million into separate SLATs for the benefit of the other, they could potentially remove $20 million from their taxable estate. Using this “dual SLAT” approach, the couple would still have $8 million in joint assets, along with any distributions from the SLATs for their living expenses.
What Are The Drawbacks To A SLAT?
Now, that example probably made it sound easy. Wouldn’t any affluent couple want to put this in place to minimize estate taxes in one fell swoop? Unfortunately, it is not so simple. Here are some of the potential issues you may encounter if you choose to employ this type of trust.
Irreversibility and control are big issues. When you make a gift to the SLAT, you give up direct control of the trust property…forever. While you can maintain indirect access to the trust through your spouse, you do lose direct access to those assets. Many people struggle with this concept, understandably. You also cannot act as a trustee of the SLAT, so you can’t have any control in how distributions are made to beneficiaries. While this estate planning tool can sound great in theory, many couples end up passing on this approach, as they ultimately don’t feel comfortable giving up so much control.
Dual SLATs can be problematic. In the example above, two spouses gifted each other equal amounts. This certainly on the surface seems like a great way to work around the control issues. However, it is not so easy. There is something called the “Reciprocal Trust Doctrine” that may get in the way. When creating dual SLATs, one for each spouse, you must be careful to make sure the SLATs are not too similar. If you end with two similar trusts, that reciprocal trust doctrine potentially allows the IRS to claim that each spouse simply made a gift to each other, and basically pull the assets back into each spouse’s estate. So aspects of the trusts should be varied, such as different beneficiaries named in the trust. Also, you should use different terms, provisions and/or timing used when creating a SLAT for your spouse.
Death can complicate things. If your spouse dies before you, you will lose your indirect access to the trust. To avoid that, your trust document should anticipate this possibility. You can have the trust terminate and distribute existing funds to your children and other family members, or you can have the SLAT continue for their benefit. You can also ask your attorney to include provisions allowing your spouse to redirect funds to you upon their death.
So as you can see, using a SLAT means you need to have proper estate planning strategies in place. This is not the type of tool to take lightly. And, when using dual SLATs, take care to not run afoul of the reciprocal trust issue.
What Happens To A SLAT In Divorce?
Another significant issue is that despite the best intentions, relationships don’t always last forever. What happens if you get divorced? In that case, you will lose the indirect access to the assets you had through your spouse, and your ex-spouse will continue to benefit from the trust.
This risk can be alleviated by including provisions in the terms of the trust to deal with a potential divorce. The SLAT can be drafted to include trust provisions that allow you to limit trust benefits to your current spouse. Or, you can incorporate language that terminates an ex-spouse’s interest in the SLAT upon divorce.
What Are The Tax Implications Of A SLAT?
There are no two ways to look at it: SLATs can be complex from a tax perspective. That’s why it is critical to work closely with your financial planner and tax planning professional to make sure you understand the full tax impact of this avenue. Here are some considerations on how adding a trust would potentially impact your tax situation.
- Estate and Gift Tax Exemptions: Currently, exemptions for estate and gift taxes are at historically high levels. It’s beneficial to use these exemptions effectively before they potentially change in 2025. Because a SLAT is an irrevocable trust, you can avoid estate tax on both the contributions and growth. However, for gifts beyond the yearly allowance, a gift tax return is normally required.
- Income Taxes: Because they are usually set up as a grantor trust, SLATs are normally viewed as separate entities for ownership purposes but not for income tax purposes. This means the spouse who creates the trust and transfers assets into it is personally responsible for paying any income taxes on the trust’s earnings, like dividends or capital gains. It’s important for the gifting spouse to be prepared for this tax responsibility. Although paying these taxes might not be pleasant, it helps the SLAT’s value increase without the burden of income taxes over time. (Also please note that the SLAT does not always have to be set up as a grantor trust for income tax purposes, even though that is the most common structure. Talk to your estate planning professional for information on other options which can change tax implications.)
- Capital Gains Tax: One important consideration to note: according to tax law, assets gifted to a SLAT do not get a step-up in cost basis at the donor’s death. Consequently, any future appreciation may be subject to capital gains taxes in the future. The beneficiary of the SLAT needs to always consider potential tax implications when selling remaining trust assets. However, historically, federal capital gains tax rates have been lower than federal estate tax rates. Also, with the trust, you have the ability to defer capital gains as well as control their timing, which you don’t get if the owner dies without the asset in a trust.
What Assets Are Best To Put In A SLAT?
As noted, assets transferred to the SLAT are considered no longer under your direct ownership. So permanent gifts to the SLAT reduce the value of your taxable estate. But what assets are best suited for this purpose?
Usually, when funding a slat, you want to select assets that are likely to appreciate. That’s because property gifted to the SLAT will no longer increase the value of your estate. While taxes will need to be paid later, this is a good way to avoid estate taxes. Instead, the assets will be subject to capital gains, which the remaining trust beneficiaries can control by choosing the time of sale.
Does A SLAT Provide Asset Protection Benefits?
When you transfer assets to the SLAT, you typically get an additional benefit: more protection from creditors. This is an often overlooked feature, as many high net worth families can be targets for litigation. By transferring assets in the SLAT, these assets are no longer part of your personal net worth. If you’re sued, creditors cannot normally gain access to these assets.
In this way, the SLAT allows not only substantial federal lifetime tax benefits in the form of lower estate taxes, it also makes you a less attractive target for any legal activity.
When Does It Make Sense To Consider A SLAT?
Many people like the idea of setting up a SLAT to benefit the beneficiary in their life (their spouse and, later, kids or other heirs). However, a SLAT is not right for every situation. If you have a large estate and want to reduce your taxable estate by making lifetime gifts, a SLAT can make sense.
While this requires you to give up all your rights to the gifted assets, the SLAT provides a safeguard because your spouse can receive trust distributions as a beneficiary, which he or she can use for your joint support and maintenance as needed. So, if you are hesitant to give away assets because you will no longer have any access to those assets, a SLAT may be a potential solution for you.
However, you must proceed with care. If a SLAT is not structured correctly, that can mean large potential headaches, loss of benefits, and possible penalties.
Pitfalls To Avoid If You Use A SLAT Estate Planning Strategy
Committing to a trust means that you must consider maintenance as well as initial setup. Unfortunately, some people don’t keep that in mind and may end up taking actions that could completely reverse the benefits. Here are some common pitfalls to be aware of.
- Avoid Commingling of Funds: Once the trust created is in place and the SLAT is funded, it’s vital to maintain a strict separation between personal finances and SLAT funds. For example, if you accidentally pay for home renovations from the SLAT account, it can be seen as misusing trust funds for personal benefit, undermining the trust’s legitimacy.
- Manage Joint Accounts Carefully: Beware joint accounts Deposits from a SLAT should not be mixed with joint marital funds. If distributions meant for the beneficiary spouse are used for expenses benefiting both spouses, it can raise questions about the trust’s integrity. Be sure to use accounts held only in the beneficiary’s spouse’s name to receive distributions from the SLAT.
- Ensure Correct Distributions: Distributions should align with the trust’s purpose. Normally, the trust beneficiary can only use SLAT distributions for certain purposes only. Using the SLAT for anything else could lead to potential legal challenges.
Key Takeaway
Bottom line? Done right, a SLAT can help your family ultimately retain millions of dollars of assets that otherwise could have been lost due to estate taxes. But as with any sophisticated estate planning strategy, caution is warranted. Only do this with the assistance of qualified specialists who are experienced in financial planning and wealth preservation. Then, you also must commit to carefully maintaining the trust so you can strive to avoid losing any of the intended benefits.
Holland Capital Management is not an attorney or accountant and does not provide legal, tax or accounting advice. This article is intended for general educational purposes only. Please consult your tax and legal advisor for advice specific to your situation.
