Wealth Planning Opportunities Post-Tax Reform: Estate Planning Using Trusts
The 2017 tax reform legislation (Tax Cuts and Jobs Act – TCJA) introduced several significant tax law changes. Some of these changes are permanent, however others are temporary; many of the temporary changes have a scheduled expiration date of December 31, 2025.
One of the more prominent changes in the 2017 TCJA legislation includes the estate and gift exemption for individuals. The TCJA legislation doubles the exemption for the estate of persons dying (and gifts made), after December 31, 2017 and before January 1, 2026. The exemption amount for 2018 is $11,180,000 per person (double the 2017 amount of $5,490,000.) The expanded exemption temporarily allows individuals to shield even more of their estate from potential estate tax. Thus, the new law provides individuals with a limited window of opportunity (2018 through 2025) to implement tactical tax saving strategies. This article will address an estate planning strategy which employs an irrevocable trust known as a Spousal Lifetime Access Trust (SLAT). A SLAT can reduce potential future federal (and state) estate taxes.
The empowering feature of a SLAT is its ability to function as an enhanced or “supercharged” bypass trust…in other words, a trust designed to provide (limited) access to income and/or principal for the needs of a surviving spouse. But, and this is the important distinction, a SLAT is funded via a gift while the donor is still alive as opposed to a bypass trust that is funded at death. The goal of a SLAT, similar to a bypass trust, is to transfer assets into a trust that will provide financial assistance to a beneficiary while excluding the trust assets from being included in the beneficiary’s estate.
Among the important advantages a SLAT offers are the opportunity to save not only federal estate tax but “state” estate tax as well. Many states have decoupled from federal estate tax law. In other words, the state estate exemption is significantly less than the federal estate exemption. For example, although the federal estate exemption is now greater than $11 million, a state such as Massachusetts only allows the first $1,000,000 of assets to be shielded from Massachusetts estate tax. This creates a differential of more than $10 million of assets that are excluded from federal estate taxation but exposed to Massachusetts estate taxation. The transfer of assets to a SLAT eliminates this mismatch of federal and state estate exemption amounts.
Potential state estate tax savings are not the only benefit offered by a SLAT. Other advantages include the following:
- Access to Trust Assets – Although the donor transfers assets to the SLAT, he/she still retains “limited” access to the assets by way of his/her spouse being the beneficiary of the SLAT. This strategy allows the donor to remove assets from his/her estate without giving up complete access to the assets.
- Additional Estate Reduction – A SLAT can be setup as a grantor trust. This means income can accrue within the SLAT but the income is taxed to the donor. The donor therefore reduces his/her overall estate even more by paying the annual income tax on behalf of the SLAT.
- Substitution Power – The donor can also include a “substitution” power that allows highly appreciated assets to be swapped for cash. This power allows the SLAT’s highly appreciated assets to be swapped out of the trust and included in the donor’s estate to receive a step-up in basis.
- Asset Protection – A SLAT provides creditor protection for any asset transferred to the trust. Transfer of the asset to a SLAT still provides the donor access to the trust assets (see above) while placing the assets out of the reach of creditors.
SLAT Complications and Concerns
As is true with most financial decisions, one must appropriately evaluate ALL planning considerations. A SLAT estate plan strategy includes weighing both the advantages and disadvantages of establishing a SLAT prior to implementation. This is particularly true when it comes to making a decision that involves the permanent relinquishment of assets. The following are disadvantages associated with a SLAT strategy:
- Divorce – The risk of a future divorce is a significant consideration for a spouse to contemplate before he/she initiates a SLAT transfer. If there is a divorce, the donor spouse would lose access to the SLAT assets. The beneficiary spouse continues to have access to the SLAT assets because the donor’s transfer of assets to the SLAT is irrevocable, which means he/she cannot undo the SLAT transfer.
- Avoiding the Reciprocal Trust Doctrine – Each spouse may wish to create a SLAT. Although this strategy is extremely advantageous, it can lead to IRS challenge if both SLATs are too similar. Essentially, the IRS will treat each donor as the beneficiary of his/her own SLAT and this re-categorization will cancel out the benefits of the asset transfers. Some of the strategies available to avoid the reciprocal trust doctrine include:
- Using different trustees or having a co-trustee for each SLAT
- Instituting different “rights” for each trust
- Selecting different beneficiaries for each trust
- Assigning different “powers” to each trust
- Funding each SLAT with substantially different assets
- Spreading out the time between the formation of each SLAT
The decision of whether or not to establish a SLAT is not necessarily limited to the very wealthy. It can be an effective estate planning strategy for couples who live in states having a significantly small estate exemption. A SLAT is an effective tool for providing immediate asset protection, especially when compared to a traditional bypass trust. That said, the consequences of a later-in-life divorce can destroy the benefits derived from a SLAT. And finally, one last SLAT consideration involves the issue of time. The changes to the federal estate tax are expected to sunset after 2025. In fact, a change could come even sooner if new tax legislation is introduced by Congress or by a different Administration. What we do know is this, after 2025, unless Congress intervenes, the estate tax provision will revert to its 2017 level.
Given the time constraints, interested parties should consider evaluating SLAT strategies in the near term to capitalize on potential wealth planning opportunities. As is the case with any estate plan strategy, couples should seek out an experienced estate planning attorney who is well versed in SLAT formation and is conversant with the reciprocal trust doctrine.
To discuss more wealth planning opportunities or explore possible trust scenarios that could benefit your future assets, please connect with us.
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