So, you are thinking about making a large gift that is sheltered from gift tax by the applicable exclusion amount. However, you have concerns about losing access to the gifted property or its income; you might not need it now, but what if things change and you do need it later? If you are married, one possible solution might be a spousal lifetime access trust (SLAT).
What is a SLAT and how does it work?
Think of you and your spouse as a family unit. A SLAT is designed to give away property for transfer tax purposes (and possibly for asset protection), while still retaining the possibility that distributions could be made to your spouse as beneficiary of the SLAT for the benefit of your family unit if the need ever arises.
Of course, if you create a SLAT for your spouse and you and your spouse divorce or your spouse dies before you, you generally lose access to the trust property and its income. However, you can provide in the trust document that any interest that your spouse has in the trust terminates upon divorce. You might even provide in the trust document that, if you remarry, your new spouse becomes the spouse with access to the SLAT.
Using exemptions and avoiding estate tax
You have a basic exclusion amount (sometimes referred to as an exemption) that can protect up to a total of $5.12 million (scheduled to drop to $1 million in 2013) from federal gift tax and estate tax, and a separate $5.12 million generation-skipping transfer (GST) tax exemption (scheduled to drop to $1 million as indexed for inflation in 2013). (There may also be state taxes to consider.)
You can use your gift tax exemption to make a gift of property to the SLAT that is sheltered from federal gift tax. In addition, the SLAT is designed so that neither you nor your spouse retains any interest that would cause the SLAT to be includable in either of your gross estates for federal estate tax purposes. If the SLAT will be generation-skipping (i.e., it has beneficiaries who are two or more generations younger than you, such as your grandchildren), you may want to allocate GST tax exemption to the trust to protect it from the GST tax.
A SLAT is generally a variation of a credit shelter bypass trust. It is common for a credit shelter bypass trust created at death to provide the surviving spouse with a right to distributions based on an ascertainable standard of health, education, maintenance, and support (HEMS). However, if your SLAT has a HEMS provision giving your spouse access to the trust while you are alive, it may cause problems for the SLAT. Such an interest could be treated as the right to discharge your legal obligation to provide support to your spouse, which would cause inclusion of the SLAT in your gross estate for estate tax purposes as an interest retained for your life. But, if your spouse’s interest is limited to distributions at the sole discretion of an independent trustee (perhaps with a HEMS provision for your spouse after your death), this problem should not arise.
Your spouse could have a mandatory right to income from the SLAT without causing the SLAT to be included in either of your gross estates. However, any income retained by your spouse until death (i.e., not consumed or given away) would be included in your spouse’s gross estate.
Can you create a SLAT for your spouse, while your spouse creates a SLAT for you? You can, but if the trusts essentially provide reciprocal benefits, merely switching you and your spouse as the spouse with access, the trust you create for your spouse will generally be included in your gross estate for estate tax purposes, and the trust your spouse creates for you will generally be included in your spouse’s gross estate. However, you can avoid this reciprocal trust doctrine by making the two trusts sufficiently different, for example, by providing that one trust also give the spouse with access a limited power to appoint trust assets at death among a group of beneficiaries, while the other trust does not have such a provision.
If you and your spouse are not trustees, and the only distributions that your spouse can receive are at the sole discretion of the trustee, creditors of you and your spouse generally cannot reach the trust assets. The trustee cannot be compelled to distribute trust assets to your spouse. So, if needed, trust assets can be retained in the trust or the trust can provide that distributions may be made to other beneficiaries, outside the reach of you and your spouse’s creditors.
Caution: Your creditors may be able to reach trust assets if you transferred the property in anticipation of claims by your creditors, if you retained insufficient assets, or if the transfers to the trust left you insolvent. A SLAT is a complicated legal document and should be drafted by an attorney.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012