One trust that married couples should consider when creating an estate plan is a Spousal Lifetime Access Trust (SLAT). A SLAT is an irrevocable trust created by one spouse for the benefit of the other spouse. There are several reasons to consider a SLAT as an estate planning strategy.
Use Estate and Gift Tax Exemptions
The current estate, gift and generation skipping transfer tax (GST) exemption is a historical all-time high of over $11 million per person. Whether a grantor’s estate is larger than that or much lower, it may make sense to take advantage of as much of the exemption as possible before the current exemptions sunset in 2025 or are changed. As with most irrevocable trusts, completed gifts using the exemption along with any future appreciation are sheltered from future estate and gift taxes.
Reduce or Eliminate Capital Gains Tax
SLATs may help reduce capital gains tax at the time of the grantor’s death. Under current law, if the trust holds appreciated assets, the grantor (or the spouse under Section 1041) could swap (or buy) the appreciated assets out of the trust and into the grantor’s name before death by transferring assets to the trust (typically cash) of an equal value. This is an estate tax neutral transaction since the same value remains in both the trust and grantor's estate. However, the appreciated assets in the hands of the grantor (or spouse) and therefore the grantor or spouse’s estate, will qualify for a step-up in basis at death, thus eliminating the unrealized appreciation or gain. If the estate tax is repealed, it could be replaced by a capital gains tax at death.
Further, a capital gains tax may be implemented for gifts of appreciated assets. Assets transferred to a SLAT before such a change may avoid any capital gains tax by gift. At death, the same swap or substitution power used above can be applied in the opposite manner as a reverse swap. If the grantor has appreciated assets in his or her estate prior to death, the grantor may be able to swap them into the SLAT prior to death and avoid a capital gains tax on death. Under either scenario, it is possible that the SLAT may provide an income tax planning opportunity.
Get Creditor Protection
As an irrevocable trust, SLATs can provide meaningful asset protection from future potential claims of creditors (i.e., protect assets in trust from malpractice claims, beneficiaries’ divorcing spouses and other suits). This protection applies to assets transferred to the trust if not characterized as a fraudulent conveyance. When a SLAT serves as an Irrevocable Life Insurance Trust (ILIT), policy cash values during the insured's life and death benefit proceeds are also protected.
Take Advantage of Grantor Income Tax Ratex
Because SLATs are a “grantor trust” this means that they are taxed to the grantor of the trust. This means that any trust earnings (i.e., dividends, interests, capital gains) are accounted for on the grantor’s personal return. This allows the trust the potential to grow “tax-free” as far as the beneficiaries are concerned, because the grantor is paying the tax bill.
It is often advantageous for trusts to be taxed at an individual level, rather than at the trust level, as the tax brackets for trusts are compressed compared to individual tax brackets for 2022 – a trust will hit the top tax rate of 37% after $13,450 of income, whereas an individual doesn’t reach the top tax rate until they exceed well over $500,000 of income. Another benefit is that the payment of those taxes by the grantor is not considered an additional gift.