SLATs See Increased Popularity Among The Married Wealthy

If you are happily married, healthy, and wealthy, a tax perk you should be talking about with your advisor is the spousal lifetime access trust, or SLAT. Its ability to whisk assets out of their taxable estates while still benefiting from them during retirement is a valuable benefit. However, a SLAT is not a simple add-water-and-mix move since it is easy to get the requirements wrong. That will void your arrangement and you could end up owing the IRS millions of dollars. When done right, some estate planners call it the perfect tax break for the perfect couple with the perfect lifestyle. The trusts are a form of so-called grantor trusts, in which a donor, or grantor, transfers assets but retains a degree of control. Last fall, grantor trusts were on the chopping block, now they are no longer in immediate danger. 

How SLATs work
A spouse sets up a SLAT for the benefit of their partner by transferring assets held in their name only. The idea is to transfer assets, including life insurance, into the trust so that your estate dips below the historically high federal exemption levels, currently $11.7 million and $23.4 million, above which the 40% gift and estate tax kicks in. The donor will pay tax on the trust’s taxable income when filing their personal return. A SLAT must have a trustee. That person cannot be the donor and can be the beneficiary only if their power to move money out of the trust is limited.

SLATs owe tax on the gains made since the original owner acquired them when the donor dies. This means that a beneficiary can owe big capital gains taxes when selling any of its holdings. However, there is a way around that hit: the donor can swap stock or property in the trust whose tax bill would be high for separate assets that have not appreciated as much. Meaning the low basis assets will now be a part of the donor’s estate and heirs would not owe gains on their appreciation while they were in the trust.

‘Not a personal checking account’
The donor spouse has effectively given the beneficiary spouse the assets. But the spouse who’s the beneficiary can request withdrawals from the SLAT to fund basic lifestyle needs and pursuits, like vacations, mortgages or home remodeling. Although, this is still not a personal checking account because the trusts are typically set up so that distributions are under what the IRS calls health, education, lifestyle maintenance or support guidelines. These so-called HEMS can get squishy come tax return time.

The IRS and children who are heirs can glom on to such potential abuses when the SLAT donor passes away, which causes the trust’s inner working and use to be detailed in the estate’s federal return. IRS employees read the trust document’s terms to see if a standard has been violated.

Divorce and death can ruin everything
If you get divorced, the donor spouse loses access to the trust. Because a transfer of assets into a SLAT is irrevocable, your ex continues post-marriage as the beneficiary, a likely bitter pill to swallow. A donor spouse whose partner dies can no longer access the trust. While there are certain ways a SLAT can be structured to allow money to be returned when a spouse dies and allow a new spouse to become the beneficiary, they can prove to be complicated.

Things get turbocharged when each spouse creates a SLAT for the benefit of the other. But even assuming our happy and healthy married couple stay that way, there are pitfalls to that twofer. Under what’s known as the reciprocal trust doctrine ban, the IRS deems to be abusive arrangements when two identical trusts are used by the same married couple to avoid estate taxes while remaining in the same economic position as beneficiaries of the trusts.

Talley’s team of tax and estate planning professionals provide comprehensive tax compliance and consulting services so you can preserve, enhance, and pass on your assets and wealth to the next generation. We welcome the opportunity to discuss the current options available for you. For more information, contact us today.