The scheduled sunsetting of the $14 million lifetime estate tax exemption presents a dilemma for some planners and clients.

The dilemma is that many people with estates that will be taxable (when and if the $14 million exemption sunsets) are not comfortable giving away a large part of their wealth.

“What if we need it?” is the common fear.

(Click here to request an Advisor Guide to Large Retirement Plans.)

Spousal Lifetime Access Trusts (SLATs) may be part of the answer. The other part, discussed below, is Asset Protection Trusts.

By establishing “his and hers” SLATs, couples can use their combined lifetime gift tax exemptions, avoid estate taxes on the assets when they die, and maintain access to trust assets should they need those assets.

Understanding Spousal Lifetime Access Trusts (SLATs)
A Spousal Lifetime Access Trust (SLAT) is an irrevocable trust created by one spouse (the grantor) for the benefit of the other spouse (the beneficiary). The trust is designed to remove assets from the grantor’s estate, thereby reducing potential estate taxes, while still providing indirect access to the trust assets through the beneficiary spouse.

Key features of a SLAT include:

• Irrevocability: Once established, the trust cannot be modified or revoked, ensuring that the assets are removed from the grantor’s estate.
• Lifetime Gifts: The grantor makes lifetime gifts to the trust, utilizing his or her gift tax exemption.
• Spousal Access: The beneficiary spouse has access to trust distributions, providing an indirect benefit to the grantor.

The Concept of Non-Reciprocal “His and Hers” SLATs
Non-reciprocal “his and hers” SLATs involve each spouse establishing a separate SLAT for the benefit of the other. The trusts must not be identical, and they cannot be “reciprocal.” This strategy allows both spouses to create trusts that provide for each other, thereby addressing the fear of not having enough.

The main difference between a SLAT and a standard estate tax planning trust is that the SLAT allows the non-granting spouse to have access to trust assets under some conditions, and yet that access does not bring the trust assets back into the taxable estate of the couple.

A SLAT will typically be set up to take advantage of both estate/gift tax exemption and Generation Skipping Tax exemptions. As such, each spouse can use his or her lifetime gift and GST exemption, effectively removing those assets from the estate tax system “forever.”

If creditor protection is a concern, the SLATs can be drafted to protect the assets in trust from future creditors and divorce settlements, providing financial security. (Attempts to shield assets from existing creditors may be considered fraudulent conveyances, or otherwise subject to voiding.)

Setting Up “His and Hers” SLATs
The process of establishing “his and hers” SLATs requires planning and coordination. Key steps include:

1. Determine Objectives: Help clients to determine their goals. Clients, should clearly define their estate planning goals, including tax reduction, asset protection, and providing for each other and future generations.
2. Identify Assets: Choose which assets to transfer to each SLAT. It’s important to consider the type of assets, their appreciation potential, and the impact on the overall estate plan.
3. Draft Trust Documents: Work with an estate planning attorney to draft the trust documents. Each trust should have distinct terms to avoid reciprocal trust issues, which can negate the intended tax benefits.
4. Fund the Trusts: Transfer the chosen assets into each trust. This process must be handled carefully to ensure compliance with tax laws and avoid potential pitfalls.
5. Manage the Trusts: Appoint a trustee to manage the trust assets. The trustee has a fiduciary duty to act in the best interests of the beneficiaries.

Reciprocal Trust Doctrine
One of the critical considerations when establishing “his and hers” SLATs is avoiding the reciprocal trust doctrine. This doctrine, established in case law, can allow the IRS to disregard the trusts if they are deemed to be too similar. In such a case, the IRS may deny the validity of the gifts, deeming the assets to remain in the estate of the grantor.

The attorney who drafts the trusts is likely to have his or her own (or the firm’s) way of making the trusts different, so that the reciprocal doctrine does not apply. Among these approaches are to vary the terms of the trusts with respect to (for example) distribution rules, beneficiaries, trustees, and assets. Another approach is to separate the creation and funding of the trusts by time, such as in different years.

Asset Protection and the Use of a Distribution Trustee
Grantors concerned about asset protection might want to use multiple trustees in different roles. For example, a grantor might have a trustee for general purposes, a separate trustee for investments, and a third trustee whose only task is to decide whether, when, and in what amounts to make distributions.

Avoiding the Basis-Step-Up Tradeoff Trap
Many couples own assets that have appreciated. One common strategy is to plan to hold such assets until one or both of the couple dies, so that the heirs can benefit from a stepped-up basis.

The drawback of this strategy is that in order to receive a stepped-up basis, the asset must remain in the taxable estate.

A solution that is compatible with a SLAT strategy is to fund the SLAT with the lead interest in an Asset Diversification Trust. 

Asset Diversification Trust
An Asset Diversification Trust is a tax-exempt trust. The grantor and typically the grantor’s spouse, children, and grandchildren, are beneficiaries of the trust. Because the trust is tax-exempt, appreciated property can be contributed to the trust. When the appreciated property (e.g. stock, real estate, crypto, a business, partnership units, private investments, or other capital gain assets) is sold in the trust, there is no capital gains tax because the trust is tax-exempt.

Thus, the basis step-up becomes irrelevant.

Asset Diversification Trust + SLAT = Best of All Worlds?
The grantors’ interest in the Asset Diversification Trust can be used to fund the SLAT. The grantors of an Asset Diversification Trust own the right to receive income from the trust. That right is itself a capital asset. It is called the “lead” interest or the “income” interest in the Asset Diversification Trust.

That capital asset can be used to fund the SLAT.

Using the lead interest in an Asset Diversification Trust to fund a SLAT can be the perfect solution for a couple who want to:

1. avoid capital gains on an appreciated asset
2. take advantage of the lifetime estate tax exemption before it sunsets3.retain the ability to access the assets they’re getting out of their estate

How to Implement
The powerful benefits of the marriage of SLATs with Asset Protection Trusts comes with specialized planning. You will probably want to use the services of an estate planning specialist for the SLATs, and a separate Asset Diversification Trust specialist for the Asset Diversification Trust.

Sterling is the leading provider of turnkey Asset Diversification Trusts, and a pioneer in the combining of the two kinds of trusts to produce the amazing combination of benefits the marriage of SLATs with Asset Diversification Trusts provides to couples.

Asset planning trusts are a powerful tool. For case studies about how such trusts have been used to diversify concentrated positions, click here to request our Case Study on Appreciated Stock. Or call 703-437-9720 and ask for Connor or Katherine. Or email [email protected] to ask for a guide or schedule a call.