In this era of high exemptions from the federal gift and estate tax, the spousal lifetime access trust (SLAT) has become a popular transfer tax savings strategy employed by married couples.

We are providing this article to you so you can discuss and consider with your legal and tax advisors whether using a SLAT is appropriate for you.

The Tax Cuts and Jobs Act of 2017 (TCJA) markedly increased the federal gift and estate tax applicable exclusion amount (colloquially known as the gift and estate tax “exemption”). In 2017, prior to the enactment of the TCJA, the federal gift and estate tax exemption was $5.49 million. In 2021 (after the enactment of the TCJA), the federal gift and estate tax exemption is $11.7 million. Thus, today, a married couple can transfer (without considering other exclusions, such as the gift tax annual exclusion) approximately $23.4 million before having to pay a gift or estate tax. Unless Congress takes further action, the exemption amount is scheduled to revert (sunset) to pre-2018 exemption levels (indexed for inflation) on January 1, 2026. Because the exemption amount is indexed for inflation, it is not possible to know exactly what that amount will be in 2026, but it is anticipated to be approximately $6 million per individual.

The Treasury Department has issued regulations[1] confirming that should the estate and gift tax exemption revert to pre-2018 levels, taxpayers who take advantage of the increased exemption amount during the time it is available will not be adversely affected when the exemption amount returns to $5 million (indexed for inflation) after December 31, 2025. Hence, there will be no so-called “claw back” of the exemption amount used during the period of the increased exemption amount over the amount available at death should the exemption amount revert to pre-2018 levels.

The prospect of a 2026 sunset of the higher exemption amount, as well as political uncertainty in the United States (such as after a congressional or presidential election, which could accelerate a reduction in the exemption amount), has prompted many families to look for ways to use the increased exemption amount before it decreases.

What Is a SLAT?

At its most basic, a SLAT is a gift from one spouse (the donor spouse) to an irrevocable trust for the benefit of the other spouse (the beneficiary spouse). Although similar to a so-called “bypass” or “credit shelter” trust, which: (i) receives assets having a value up to a deceased spouse’s remaining exemption from the federal estate tax; (ii) potentially benefits the surviving spouse; and (iii) prevents the value of the trust (the assets transferred and appreciation thereon) from being included in the surviving spouse’s gross estate (and subject to estate tax) when the surviving spouse dies, the SLAT is funded by gift while both spouses are alive.

The beneficiary spouse can receive distributions from the SLAT, yet the SLAT is designed to be excluded from the beneficiary spouse’s gross estate and to not be subject to estate tax when the beneficiary spouse dies. To prevent the value of the assets of the SLAT from being included in the beneficiary spouse’s gross estate, the SLAT will not qualify for the gift tax marital deduction (either because the donor does not make the necessary election or the terms of the trust prevent it from qualifying).

This allows the donor spouse’s exemption from the gift and estate tax to be applied to the value of the assets transferred to the SLAT, sheltering the transfer from gift tax.

Of course, if the value of the assets transferred to the SLAT exceeds the amount of the donor spouse’s available gift tax exemption, a gift tax will actually be paid — not a desired result.

The terms of a SLAT can be flexible. To qualify for the federal gift tax marital deduction, the beneficiary spouse must, generally, receive all of the trust’s income for life. However, because a SLAT does not qualify for the federal gift tax marital deduction, this restriction does not apply. Although the SLAT can be drafted to require the beneficiary spouse receive the trust’s income for life, this is not necessary, allowing the SLAT to have multiple current beneficiaries, such as the beneficiary spouse and the couple’s descendants.

Attributes of a SLAT

For married persons who want to take advantage of the increased exemption from the estate and gift tax, but are not sure that they can irrevocably part with so much wealth, a SLAT may be an appropriate solution.

A SLAT allows the donor spouse to transfer up to the donor spouse’s available exemption amount without a gift tax. When the donor spouse dies, the value of the assets in the SLAT is excluded from the donor spouse’s gross estate and are not subjected to the federal estate tax. However, because the donor spouse will have used the exemption amount to shelter assets transferred to the SLAT from the federal gift tax (so that the exemption amount used is no longer available to shelter assets in the donor spouse’s estate from estate tax), it is the appreciation on the assets in the SLAT that truly escapes federal estate tax. Because there is no claw back, any exemption amount used when the trust was funded over the exemption amount allowed at the time of the donor spouse’s death should also escape federal estate tax.

The donor spouse can allocate the exemption amount from the generation-skipping transfer tax to the SLAT, making it exempt from future estate tax for many generations.

To achieve these tax benefits, the SLAT must be an irrevocable trust. To that end, when creating a SLAT, the donor spouse must irrevocably transfer assets to the SLAT, forever parting with the income from and use of those assets. Yet, income from and perhaps the assets themselves may not be lost to the couple. Depending on the terms of the SLAT, the beneficiary spouse, as a potential beneficiary of the SLAT, could receive distributions of income or principal from the SLAT, allowing the beneficiary spouse (and the donor spouse, indirectly) to access the transferred assets if needed. Of course, by accessing the assets in the SLAT, unless those assets are consumed, the couple returns assets to one of their estates, potentially subjecting their value to estate tax at death and losing some of the benefit of the original transfer. This “leakage” should be avoided, if possible.

For federal income tax purposes, a SLAT is treated as a “grantor trust.”[2] This means that the donor spouse, as the grantor of the SLAT, is for income tax purposes treated as owning the assets of the SLAT. As such, the income from the trust’s assets is included in the donor spouse’s gross income, requiring the donor spouse to pay income tax thereon. Although the donor spouse pays income tax on income received by the trust (and not by the donor spouse), this has the added benefit of allowing the assets of the trust to compound without being diminished by income taxes. Because the donor spouse is obligated to pay the income tax attributable to the trust’s income, this tax payment is not a gift to the trust (and is not subject to gift tax).

Transferring assets to a SLAT may also provide a measure of protection from creditor claims on both the donor spouse and the beneficiary spouse. Assuming the transfer to the SLAT is not a fraudulent conveyance, because the donor spouse has parted with dominion and control over the transferred assets and has not retained any interest in or become a trustee of the SLAT, the transferred assets should be free from the claims of the donor spouse’s creditors. Further, assuming that the terms of the SLAT include a proper spendthrift clause, preventing the assignment of the SLAT’s assets by its beneficiaries, if the beneficiary spouse has only a discretionary interest in the SLAT (that is, the beneficiary spouse will receive trust income or principal only in the discretion of an independent trustee) the assets of the SLAT should also be exempt from the beneficiary spouse’s creditors.

However, if the beneficiary spouse has the right to receive income or principal from the SLAT (for example, if the terms of the SLAT require income to be paid to the beneficiary spouse), the beneficiary spouse’s creditors could obtain that property as it is paid to the beneficiary spouse.

Of course, the law with respect to the enforcement of creditors’ claims varies from state to state and is affected by federal bankruptcy law, so results may differ by state.

Be Cautious When Creating a SLAT

The general rules regarding the creation of irrevocable trusts that are intended not to be included in the donor’s or beneficiary’s gross estate should be followed when creating a SLAT. For example, when naming a trustee:

  • The donor spouse should not be a trustee of the SLAT.
  • If the beneficiary spouse is trustee of a SLAT, distributions should be mandatory or subject to an ascertainable standard.
    • An ascertainable standard restricts distributions from the SLAT to providing for a beneficiary’s health, education, maintenance, and support. These are measurable amounts and can be enforced by the court having jurisdiction over the SLAT.
    • Of course, to the extent the beneficiary spouse has the right to receive income or principal from the SLAT, the beneficiary spouse’s creditors may be able to attach those assets.
  • Consider appointing a trustee who does not have an interest in the trust to make discretionary distributions among a number of beneficiaries (including the beneficiary spouse).

As described above, a SLAT is a grantor trust, and the donor spouse pays the income tax on the SLAT’s income. Care should be taken to avoid causing the donor spouse to be taxed on the trust’s income without having the resources to pay the tax. For example, were the SLAT to realize a large capital gain (such as from the sale of a business owned by the trust), the donor spouse, who is deemed to own the assets of the trust, would have to pay the income tax on such gain, possibly depleting the donor spouse’s personal assets. Yet, it may be difficult to prevent a SLAT from being treated as a grantor trust. Internal Revenue Code Section 677(a) provides that “the grantor shall be treated as the owner of any portion of a trust … whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be- … distributed to the grantor or the grantor’s spouse;… [or] held or accumulated for future distribution to the grantor or the grantor’s spouse.”

Accordingly, it may only be possible to turn off grantor trust status by permitting distributions from the SLAT to be made by, or only with the consent of, a trust beneficiary whose interest in the trust would be potentially diminished by a distribution to the beneficiary spouse. For example, assume the income of a SLAT could be distributed among the beneficiary spouse and the couple’s children. Because a distribution to the beneficiary spouse would diminish the children’s ability to receive a distribution, the children would be adverse to the beneficiary spouse. If distributions to the beneficiary spouse required the consent of the children (absent another provision of the trust that would cause grantor trust status) the SLAT would not be a grantor trust.

As described above, even though the SLAT is a grantor trust for income tax purposes, its value is excluded from the donor spouse’s and beneficiary spouse’s gross estates. Because the SLAT is not subject to estate tax, when either spouse dies, the tax basis of the assets in the SLAT will not be adjusted to their fair market value at either death (known as a step-up in basis).[3]

The donor spouse should contribute individually owned assets to the SLAT. Jointly held assets (or assets held as a tenancy by the entirety) must be broken into individually owned assets before the donor spouse contributes them to the SLAT.

Because transfers between spouses are not subject to gift tax, the donor spouse can receive a gift of property from the beneficiary spouse, which is then contributed to the SLAT. Some amount of time should elapse between the gift to the donor spouse and when the donor spouse contributes assets to the SLAT. Not allowing enough time to elapse between transfers could permit the IRS to invoke the “step-transaction doctrine,” which collapses multiple steps into one single integrated transaction. In that event, the beneficiary spouse could be deemed to have contributed assets to the SLAT, potentially causing some (or all) of its value to be included in the beneficiary spouse’s gross estate and subjected to estate tax. Note also that dividing a tenancy by the entirety between the spouses subjects one-half of the property to the creditors of each individual spouse, eliminating the creditor protection offered by the nonseverable tenancy by the entirety.

The flexibility of the SLAT results in great part from its ability to distribute income and principal to the beneficiary spouse, which can be used by the family unit, including the donor spouse. The ability, albeit indirectly, of the donor spouse to access the funds in the SLAT through the beneficiary spouse will end should the beneficiary spouse die while the donor spouse is alive. Furthermore, statistics show that more and more married couples are divorcing in their later years. Following a divorce, the ability of a donor spouse to indirectly access the funds in the SLAT will cease. Following a divorce, if the beneficiary former spouse remains a beneficiary of the SLAT, the trust will remain a grantor trust, meaning that the donor spouse will continue to pay income tax on a trust benefiting a now former spouse.[4] Accordingly, as difficult as it is for couples to contemplate while married, planning for divorce should at least be considered when drafting the terms of any SLAT.

Too Much of a Good Thing

There is an old adage: “What’s sauce for the goose is sauce for the gander.” Some married couples, desiring maximum tax benefit, will create two SLATs, with each spouse creating a SLAT for the other. This allows each spouse to fund a SLAT with the maximum exemption available to the spouse.

Nevertheless, when each spouse creates a SLAT for the other, it is important to draft the trusts so that the IRS will not invoke the reciprocal trust doctrine, which would cause the value of the trust that each spouse created for the other spouse to be subjected to estate tax in the creator spouse’s estate.

The reciprocal trust doctrine is designed to avoid abusive situations, such as where two spouses create identical SLATs for the other, seeking to avoid estate tax on the value of the trusts. The reciprocal trust doctrine allows the IRS to “uncross” the trusts, so that each spouse is deemed to have created a trust for such spouse’s own benefit. As a result, the value of each trust will be included in the gross estate of the spouse who created the trust and subjected to estate tax when that spouse dies.[5] As the United States Supreme Court has stated:

[A]pplication of the reciprocal trust doctrine is not dependent upon a finding that each trust was created as a quid pro quo for the other. … Nor do we think it necessary to prove the existence of a tax-avoidance motive… Rather, we hold that application of the reciprocal trust doctrine requires only that the trusts be interrelated, and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries.[6]

Carefully drafting and funding multiple trusts can help avoid application of the reciprocal trust doctrine. Following are some ways to potentially avoid application of the doctrine.

  • The trusts should contain dispositive provisions that are substantively dissimilar so that the spouses are not in the same economic position after the creation of the SLATs:
    • One trust could require that all of its income be paid to the beneficiary spouse each year, while the other trust allows the trustee to distribute income among the beneficiary spouse and the spouses’ descendants.
    • One trust could prohibit distributions of principal, while the other could grant the trustee discretion to distribute principal to the beneficiary spouse.
    • One trust could give the beneficiary spouse a testamentary or lifetime limited power of appointment,[7] while the other trust would pass only to the beneficiaries named in the trust.
  • Each trust could have a different trustee.
  • Ample time should elapse between the creation of each trust. It may be helpful to create each trust in a different tax year.

It may be tempting for a married couple to seek maximum estate tax benefit by funding a SLAT (or mutual SLATs) with an amount equal to the full exemption from estate and gift tax. However, it bears repeating that transferring assets to a SLAT places them under the control of a trustee. If the trustee has discretion to determine who among multiple beneficiaries will receive distributions of income or principal from the SLAT, there is no guarantee that the beneficiary spouse will receive anything from the trust. In short, a couple should not fund a SLAT to such an extent that the couple’s asset base is reduced below what is necessary to maintain their lifestyle. Accordingly, before undertaking a SLAT strategy, consult with your financial advisor, who can prepare a personal financial plan illustrating the potential impact of making a gift to a SLAT.

Example: 

For many families, the thought of using both spouses’ full exemptions from the estate and gift tax may be daunting (or, simply impractical). Instead, couples may find it desirable to use some of both spouses’ exemptions or all of only one spouse’s exemption.

If the donor spouse today creates a SLAT using the donor spouse’s entire exemption, the other spouse’s exemption would remain available even after the sunset, albeit at a reduced amount. Creating a SLAT today could potentially shelter more wealth from the estate tax than would doing nothing. To illustrate: If in 2021 the donor spouse uses $11.7 million to fund a SLAT and in 2026 the exemption reverts to $6 million, were the other spouse to create a SLAT (or die) in 2026, using the exemption at that time, the couple would have exempted from estate and gift tax, in the aggregate, $17.7 million. Had the couple not created the SLAT in 2020, and both died after the sunset, at a time with the exemption was $6 million, the total amount exempted from estate tax would be $12 million. Accordingly, on these facts, by engaging in SLAT planning now, the couple would be able to exempt from the estate and gift tax an additional $5.7 million.


Consider Planning for the Reduction in Exemption Now

To quote Yogi Berra: “It’s like déjà vu all over again.” Late in 2012, it remained unclear whether Congress would allow an increased estate tax exemption to sunset. At that time, the estate tax exemption was $5.12 million, and was scheduled to revert to $1 million on January 1, 2013. Fearing that the higher exemption amount would expire following the end of 2012, people rushed to create SLATs at the end of the year. In the end, Congress did not allow the increased exemption amount to expire.

While 2026 appears to be a long way off, now is the time to begin planning. Currently, there is time to carefully consider (without being caught in the inevitable year-end rush in 2025) the impact of an irrevocable gift, whether to a SLAT or another type of plan. 

Now is the time to plan for how a SLAT might meet the needs of your family, now and for years to come.

For more information, please consult your PNC Advisor or contact PNC Wealth Management.