Pros and Cons of SLATs for Married Couples

In recent years, the most talked about tool among estate planners probably is the spousal lifetime access trust, or SLAT.

The major appeal of a SLAT is a person can continue to benefit from valuable assets while shielding them from estate and gift taxes. It’s a way to hedge against the lifetime estate and gift tax exemption being slashed.

A substantial reduction in the estate tax exemption is a real threat. Several proposals were actively discussed and moved part of the way through Congress in 2021. The current exemption is scheduled to be cut in half after 2025 if Congress doesn’t act.

But a SLAT has advantages other than estate and gift tax reduction, so you don’t want to accept or reject it based solely on the probability of facing federal estate taxes. It can be beneficial to families whose estates are well below the taxable amount, even if the exemption is reduced by half. You also need to be aware of potential disadvantages of a SLAT.

A SLAT is for married couples who are confident their marriages will last.

Usually, a SLAT really is two trusts. Each spouse creates an irrevocable trust that names the other spouse as beneficiary and their children as contingent beneficiaries. The spouse creating the trust transfers assets to the trust.

The trusts must have independent trustees, who should be able to make distributions at their discretion.

When properly drafted, there are no gift taxes when the trusts are created, because spouses can make unlimited tax-free gifts to each other. The trust property also should be excluded from the federal estate of the spouse who created the trust and be protected from his or her creditors. The assets also will be out of the estate of the other spouse, because he or she is only a lifetime beneficiary.

Because the other spouse is primary beneficiary, the spouse who created the trust continues to benefit from the trust assets. The trustee makes discretionary distributions to the spouse beneficiary, and presumably the other spouse will benefit directly or indirectly from most of those distributions as they are spent in ways that benefit the household.

SLATs are very flexible, so a SLAT can be designed to meet different goals and needs.

Let’s look at some important details of SLATs.

As mentioned, the assets in the trust are likely safe from creditors of the spouse who created the trust. Distributions go to the other spouse, so even after being distributed in most states, the assets will be safe from the trust creator’s creditors.

An experienced estate planning attorney should draft a basic SLAT for around $5,000, perhaps less, depending on where you live. You might be able to appoint a reliable friend or relative as trustee to avoid the costs of a professional or institutional trustee.

An annual income tax return on Form 1041 must be filed by the trust. The return should be straightforward, so you can prepare it yourself or have a tax preparer do it for a modest fee.

The trust will have the same tax basis in the assets transferred to it that the trust grantor had, creating the potential for capital gains taxes when those assets are sold.

But it’s sometimes possible to structure the trust to reduce capital gains taxes on highly appreciated investments.

An older relative can be granted what’s called a “general power of appointment,” allowing the individual to name anyone as a primary or contingent beneficiary. You, of course, would want to give this power to someone who isn’t likely to exercise it.

After the person with the power of appointment passes away, the tax basis of the assets is increased to their current fair market value. That eliminates capital gains taxes on the appreciation that accrued to that date.

There must be differences between the SLATs of the two spouses. When the trusts are substantially similar, under the reciprocal trust doctrine the IRS will treat the spouses as though they made gifts to each other, ignore the trusts, and include the assets in their estates.

An estate planner should be able to draft SLATs with substantive differences so that your goals are met without triggering the reciprocal trust doctrine.

Don’t name the trusts as beneficiaries or owners of qualified retirement plans. That will increase taxes on the retirement plans.

A SLAT isn’t for assets and income used to pay regular expenses. That’s because the IRS and courts don’t like SLATs. When the trusts are used to fund regular expenses, especially expenses that cover both spouses, the trust assets could be treated as though the spouses never gave up control. The SLATs and their tax benefits would be ignored.

A key potential downside of a SLAT is that when one spouse dies, the other spouse no longer benefits from the income and assets of the SLAT. Future trust distributions go to the contingent beneficiaries.

If you think losing indirect benefits from the SLAT in the future would reduce your standard of living, consider buying life insurance on the other spouse.

The SLATs are irrevocable. That’s one reason the couple should be confident in the durability of the marriage.

The irrevocable nature of the trust also might be a good reason to appoint a trust protector. This is an independent person empowered to take actions such as replacing a trustee or appointing a successor trustee. The protector also can change the state in which the trust is located in case changes in tax laws or other laws make that advisable.

A protector shouldn’t be you, your spouse or another beneficiary of the trust. It could be a reliable relative, friend or professional advisor.