The Tax Cuts and Jobs Act (TCJA) roughly doubles the transfer tax exemption from $5.6 million per individual to $11.18 million per individual or $22.36 million per married couple.
The only catch: the exemption amount has an expiration date. The law has scheduled the exemption extension to sunset in 2025. Unless Congress acts to further extend the transfer tax exemption amount, it will return to the previous $5.6 million rate in 2026.
The wealthy can use estate planning tools to make the most of this increased exemption amount, effectively safeguarding the extended amount even if it does sunset as scheduled. One legal tool that can help achieve this goal: the SLAT.
What is the SLAT? The spousal lifetime access trust (SLAT) is a type of irrevocable trust with the creator's spouse and issue listed as the beneficiaries. If structured wisely, a SLAT can remove assets from the family's estate, provide access for a spouse while also protecting the asset from creditors.
What are the pros and cons of this tool? Like any legal tool, there are benefits and risks associated with its use. The primary benefit is the ability to remove assets from one's estate and take advantage of the increased lifetime estate tax exclusion amount before it sunsets in 2026. This technique utilizes discounting to further leverage the share of the property to be gifted. The creator can be treated as the "owner" of the gifted asset for income taxes, and he or she pays the income generated by the SLAT, not the beneficiaries.
A big consideration or risk is that SLAT assets do not receive a basis step-up on death of the creator. Income taxes on appreciated assets will be paid by the SLAT or its beneficiaries. Another risk to take into consideration before developing a SLAT is divorce. Generally, the spouse would still reap the benefits of the SLAT in the event of a divorce. This risk may be minimal in states such as California where property acquired during marriage is community property. The IRS can challenge the underlying value of the assets transferred to the SLAT. The SLAT trustee should be an independent trustee.
What if we already have a SLAT? It is wise to review the language of the trust. A recent piece in Think Advisor notes the reciprocal trust doctrine could apply. This rule may result in a challenge to trusts in this situation, if the terms of each spouse's SLAT are found to be identical. The government is attempting to avoid allowing couples to develop two identical trusts to benefit each other while removing the assets from their estate. Adjustments to the language of the SLAT can help mitigate this risk.