By Daniel F. Rahill, CPA, JD, LL.M., CGMA.
The inheritance tax exemption limit for 2021 is $ 11.7 million per person (inflation-indexed) with a top tax rate of 40 percent. After 2025, that amount will revert to the pre-2018 exception, which is an indexed amount that would be about $ 5.8 million in current dollars. President Biden's campaign platform proposed accelerating the reduction of the tax exemption to $ 3.5 million with a top tax rate of 45 percent, most likely in 2022.
In his "For the 99.5 Percent Act," Senator Bernie Sanders goes even further and suggests reducing the inheritance tax exemption to $ 3.5 million, which is not inflation-indexed. The Sanders' plan would reduce the gift tax exemption from $ 11.7 million to $ 1 million and increase inheritance and gift tax rates up to 65 percent.
These proposals lead individuals and families expecting taxable estates to look for ways to claim their lifetime exemptions in 2021. Traditionally, this gift would take the form of gifts to children, grandchildren or trusts for their benefit. However, many customers are reluctant to forego access to a significant amount of money. Or customers may be reluctant to give their children or grandchildren immediate access to the transferred assets.
Lifetime spouse access trusts
Given the changes currently being proposed to inheritance and gift tax laws, and knowing that inheritance tax exemption will definitely be cut in half after 2025, many married clients enter into an estate planning escrow agreement known as the "Spouse for Life" Access Trust " or SLAT. A SLAT offers married customers flexibility in the design of gifts and at the same time takes advantage of a potentially vanishing lifelong exclusion from gifts.
A SLAT is an irrevocable trust created by one spouse (referred to as the "grantor spouse") for the current benefit of the other spouse (referred to as the "beneficiary spouse"), with the remainder usually in the deceased's children at death of the eligible spouse. For many customers, the term “spouse access for life” reflects the main advantage of a SLAT, namely that the eligible spouse can receive distributions from the SLAT. For example, if the couple's financial situation deteriorates after a donation, distributions from the SLAT can be made to the beneficiary spouse.
A dozen reasons why SLATs make sense
- A SLAT can make distributions to the beneficiary spouse that are necessary for their health, education, maintenance or support (HEMS). This means that the SLAT can essentially cover half of the budget expenditure. (However, by returning some of the property, the couple loses some of the inheritance tax benefit of the original transfer.)
- From a trustee perspective, a beneficiary spouse can act as a trustee but would be limited to making distributions to themselves in accordance with the HEMS standard. A trustee other than the beneficiary's spouse may be authorized to distribute assets from the trust to the beneficiary beyond what is necessary for HEMS, as long as there is no agreement between the beneficiary and the trustee that the trustee will make such distributions in excess for HEMS is allowed.
- SLAT may appoint a distribution trustee and an investment trustee as the grantor may believe that the trustee, who could be an investment professional, may not be the most desirable person to make distribution decisions for beneficiaries. A co-trustee should also be considered to assist with the administration.
- The main beneficiary is usually the spouse of the donor, with siblings, children, grandchildren or other descendants being named as the current or remaining beneficiaries, but the trust can also be structured with flexible power of attorney. An independent trustee has the option of transferring all of the assets of the SLAT to the beneficiary spouse.
- After death, the assets of a SLAT are not included in the estate of the granting spouse or the beneficiary spouse. Gifts from the donor's spouse to SLAT count towards the $ 11.7 million lifetime transfer tax exemption in 2021 as we seek to "use or lose" that exemption in this environment.
- Any increase in the value of the transferred property between the time of transfer and the date of death is not subject to inheritance tax in the event of death. In addition, if the intergenerational transfer tax exemption is assigned to an SLAT, it can be structured to create “dynasty” trusts for children and grandchildren after the death of the beneficiary spouse, which means that these trust assets are not included in their estate .
- The transfer of assets to a SLAT can also provide protection from creditor claims by both the donating spouse and the beneficiary spouse, provided that there is no fraudulent transfer and the trust has an independent trustee.
- For income tax purposes, a SLAT can be treated as a "Grantor Trust" which means that all income, deduction and credit items are attributed to the grantor spouse and not to the trust itself. The donor's payment of income tax liability for the SLAT is not considered a taxable gift, effectively allowing the donor to make further transfers to the trust beneficiaries without taking advantage of a transfer tax exemption. As a grantor trust, the SLAT pays no income tax but should file a blank tax return with a declaration stating that the income and expenses are included on the donor's tax return.
- The SLAT may lend money to the grantor and family members on arm's length terms, or exchange or sell assets to the trust.
- Currently, when determining the value of a minority or voting interest in an LLC or other business on a sale or transfer, a discount may be taken into account, thereby increasing the value of the transfer for inheritance and gift tax purposes.
- If a holiday home belonging to the Schenker spouse is transferred to the SLAT, the Schenker spouse has the option of paying rent to the trust. This would have no income tax consequences for the donor if the SLAT is a donor trust that enables the donor to make additional gift tax-free transfers to the trust.
- In the event of divorce, the trust can split into a SLAT for the beneficiary of the spouse and another SLAT for the descendants of the deceased with a new trustee. For the possible death of an eligible spouse and in the event that the testator enters into a new marriage, variable spouse provisions can also be included.
Spouses wishing to establish mutual SLATs must be aware of the "Reciprocal Trust Doctrine," which states that if the two trusts are too similar, the assets of both trusts could be included in their respective estates if challenged by the IRS become. In addition, the trusts may be subject to creditor claims. Therefore, trusts should not be created in mirror images of each other. It is more certain that a trust funded by the receiving spouse is only for offspring. For individuals, there are alternatives that can work too. One of these is a variant known as a domestic asset protection trust, approved in 19 states, where the grant recipient can be the beneficiary of their own access trust.
SLATs are a powerful estate planning tool for couples who would be reluctant to transfer a significant portion of their wealth to their children and thereby lose all access to these funds. Given the proposed changes to tax law that would partially impact the benefits of SLATs, now is the time to contact your investment or family office banking advisor to help develop tax saving strategies for you and your family. If you have any questions, we will be happy to address your specific situation.
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Daniel F. Rahill, CPA, JD, LL.M., CGMA, is Managing Director at Wintrust Wealth Management. He is also a past chairman of the board of the Illinois CPA Society and currently serves on the board of the American Academy of Attorney-CPAs.