This is the eighth installment in a blog series on opportunities for tax planning in the current low-interest rate environment. Read our previous installments here.

A Spousal Lifetime Access Trust (SLAT) is a type of trust that provides an opportunity for the grantor of the trust to utilize his or her remaining estate and gift tax exemption while also allowing the grantor’s spouse to benefit from the assets transferred.

The creation of a SLAT is a popular technique that can be used to take advantage of the increased estate and gift tax exemption amount, particularly when there is a risk that the exemption will be reduced. Currently, the estate and gift tax exemption ($11,580,000 in 2020) is set to revert back to $5 million, adjusted for inflation, beginning Jan. 1, 2026, though it is possible there could be a reduction in the exemption amount sooner. For this reason, an individual may wish to consider creating a SLAT prior to the exemption being reduced.

To take advantage of the higher estate and gift tax exemption, the grantor transfers an amount equal to his or her remaining lifetime estate and gift tax exemption in assets such as cash, marketable securities, and/or closely held business interests to a new trust that primarily benefits the spouse. Although a lesser amount can be transferred, to maximize the use of the increased exemption amount, it is important that the amount of the transferred assets exceed the amount to which the exemption is reduced in the future. This is because the U.S. Treasury and the Internal Revenue Service (IRS) have already stated that any exemption used under the increased exemption amount will not be subject to “claw-back” if and/or when the exemption amount decreases (essentially the exemption is “use it or lose it”). For example, if an individual who has $11,580,000 in estate and gift tax exemption remaining makes gifts equal to $11,580,000, and the exemption is later reduced to $5 million (adjusted for inflation), then the individual would be treated as having no exemption remaining. The individual will not be penalized for having made gifts in excess of the lower exemption amount and will have fully utilized the increased portion of the exemption amount. Alternatively, if an individual has $11,580,000 in exemption remaining, makes gifts equal to $5 million, and the exemption is later reduced to $5 million, the individual would still be treated as having no exemption remaining and will have lost the opportunity to use $6,580,000 of estate and gift exemption.

Following the creation of the SLAT, the value of the transferred assets, income from such assets, and any appreciation is removed from the grantor’s and the spouse’s taxable estates (except any amount of distributions made to the spouse). Upon the death of the spouse, the remaining trust assets pass to the remainder beneficiaries of the trust (typically the grantor’s descendants). This will occur even if the grantor is living. Generation-skipping transfer (GST) tax exemption can be allocated to the SLAT at the time of the initial transfer, so that the trust assets will be able to be passed from generation to generation free of transfer taxes. That is, the SLAT can be designed to last in perpetuity. However, the assets will generally not be available to the grantor if a divorce occurs or the spouse predeceases the grantor.

The terms of the SLAT and the manner of funding the SLAT can be varied to provide more planning flexibility. For example, the SLAT could be structured in a manner so that the grantor can make a qualified terminable interest property (QTIP) election to qualify the gift for the marital deduction if the grantor decides that the use of his or her exemption does not make sense. The decision to make a QTIP election could be made as late as October 15 of the year following the year of creation of the SLAT. Also, rather than gifting assets to the SLAT, the SLAT could instead be funded by the grantor selling assets to the SLAT in exchange for a promissory note. This too could provide flexibility by allowing the grantor to either undo the transaction by requiring that the note be paid back if the transfer does not make sense, or by forgiving the note by the end of the year, resulting in a gift to the SLAT to utilize the grantor’s exemption amount.

Frequently, spouses may each choose to create a SLAT as grantor in order to use both of their increased exemptions. If this is the case, it is important to carefully structure the trusts to minimize a challenge by the IRS under the “reciprocal trusts doctrine.” This doctrine generally states, for example, that if a husband creates a trust for his wife, and the wife creates a nearly identical trust for the husband, then the two trusts may be “un-crossed” and treated for transfer tax purposes as if each spouse had created a trust for himself or herself. This can be avoided by varying the terms of the trusts such as by changing the remainder beneficiaries or allowing one of the spouses to have a power of appointment over the trust assets.

Given the current uncertainty with respect to potential changes to the exemption amount, the flexibility of a SLAT, both in structure and manner of funding, make it a useful tool for individuals concerned about a reduction in the exemption amount who still want to maintain a certain level of asset access.