Synopsis

The estate and gift tax exemption is set to be cut in half at the end of 2025.  Estate planners are seeing an uptick in client inquiries who are seeking to utilize their exemptions prior to the scheduled reduction.  For many of these clients that know they should use their exemptions now but are not sure they can, the SLAT may be a good technique.  This article provides an in depth analysis of SLAT planning.

Introduction

Making gifts is a core part of the estate planning process.  Giving things away when they aren’t worth a lot, so when those assets become worth a lot they are outside the donor’s estate (in effect, “on the other side of the tax fence”), allow individuals to leverage their exemptions from gift and estate tax.  Valuation discounts also allow individuals to leverage exemptions even if the assets don’t appreciate.

That exemption, known as the applicable exclusion amount (referred to as the “exemption” in this article), is one of the most important tools an estate planning attorney has to assist clients in helping save estate taxes.  Though clients often want to “save” their exemption to use at death, doing so is not the most efficient use.  If a client has a $13,610,000 exemption, at death estate tax on $13,610,000 is avoided.  Assuming a 40% estate tax rate, $5,444,000 of estate taxes are saved.  However, if the client made a gift of assets worth $13,610,000 twenty years prior to death, at 7% that asset would have appreciated to $52,666,406.  Estate tax on that amount saved is $21,066,562.  There is significant leverage in using the exemption sooner rather than later.

Pairing the use of the exemption with the generation-skipping tax (“GST”) exemption (referred to as the “GST exemption” in this article) provides greater benefit.  A gift outright of assets to children of the amount of the exemption avoids estate tax on the appreciation, but those assets are subject to estate tax when the children die.  If, instead, the donor had given that asset to a trust for children and allocated GST exemption to the gift so that the trust had an inclusion ratio of zero, transfer taxes would be avoided when the children died and the assets passed to grandchildren.[1]  And if the trust were established in a state where there is no rule against perpetuities, under current law, those assets (including the appreciation thereon) could pass literally forever, from generation to generation, without incurring transfer taxes.[2]

The amount of the exemption has increased at times since the modern exemption became part of the tax law[3]:

Year	Exemption
1982	$600,000
2001	$675,000
2002	$1,000,000
2004	$1,500,000
2006	$2,000,000
2009	$3,500,000
2010	Repealed
2011	$5,000,000[4]
2018	$11,180,000[5]
2019	$11,400,000
2020	$11,580,000
2021	$11,700,000
2022	$12,060,000
2023	$12,920,000
2024	$13,610,000

However, also over that period, there were many times where Congress considered a reduction in the amount of the exemption.  In the recent past, Congress was ready to vote in 2005 to reduce the exemption to $1,000,000 (that vote never took place as Hurricane Katrina devastated New Orleans and made Congress turn its attention to other matters).  It was believed that when the estate tax “came back” after repeal in 2011, the exemption would be reduced to $2,000,000.  When Joe Biden was elected President, there was a strong feeling that he would reduce the amount of the exemption significantly when he took office in 2021.

None of those reductions took place.[6]  However, in each of those circumstances, there was a mad rush to “use it before you lose it” – and estate planners helped their clients make significant gifts prior to the anticipated reduction in the amount of the exemption at each of those moments in time.  However, client reactions to the advice that they use their exemptions varied depending on the net worth of the particular client.

Billionaires just made gifts to use their exemptions to trusts for their children without complaint.  They could afford to make those gifts without impacting their lifestyles.  And they recognized the significant transfer tax savings that could be achieved through the use of a larger exemption amount.  Those trusts also were allocated GST exemption, so that assets given to these trusts, along with the appreciation on those assets, would pass without imposition of GST tax.  For billionaires, such gifts were “rounding errors”.[7]

For people worth in the hundreds of millions of dollars, there was more consideration given to the decision.  However, many ultimately decided that they could afford to make those gifts, saw the tax benefits, and transferred assets before the anticipated drop in the amount of the exemption (which, as we know, never came).  Having hundreds of millions of dollars was enough to make people comfortable that even if they used their exemption before losing it, they would still have enough to provide for their lifestyles for the balance of their lifetimes.

People with assets valued at around twice the amount of the exemption had the hardest time deciding whether to make the gifts or not.  They recognized the tax benefit of using it before losing it, but weren’t sure that they could afford to live their lives after making gifts of such a significant portion of their net worth.[8]

The latest increase in the amount of the exemption came courtesy of the Tax Cuts and Jobs Act (the “TCJA”), which became effective on January 1, 2018.  On December 31, 2025, the exemption is scheduled to be cut in half – back to around $7,100,000 per person.

Of course, Congress could always enact legislation to change that sunset provision of the TCJA, and keep the amount of the exemption from falling.  However, this time “feels” different than it did in the past.  In most past occurrences, Congress would have had to enact a law to reduce the amount of the exemption.  Now, similar to 2012, Congress must enact a law to avoid the reduction in the amount of the exemption that is already baked into the law.  In 2012, Congress avoided the sunset that would have reduced the $5,000,000 (adjusted for inflation) exemption to $1,000,000 (and a 55% estate tax rate) when it enacted the American Taxpayer Relief Act of 2012.  However, with the highest exemption in history, 2026 might be the year that the amount of the exemption actually falls.  On the other hand, if the Republicans control Congress and the White House, there may even be a push to repeal the estate tax.  No one knows what will happen.[9]

As a result, clients must again decide whether to use their exemptions before the end of 2025, or perhaps miss the tax savings from higher exemption amounts that are reduced by, in this instance, the sunset of the TCJA.  And many clients must now decide whether they can afford to maintain their lifestyles if they give away what could amount to about half their net worth.

In 2012 and 2020, an estate planning technique for married couples referred to as spousal lifetime access trusts (“SLATs”) was employed to enable certain clients to make gifts and utilize their exemptions without fear of being unable to live their lifestyles thereafter.  As the end of 2025 fast approaches, we can expect SLATs to again become an option that estate planners discuss with many of their clients.  The purpose of this article is to address SLATs in detail and to identify the many nuances that must be addressed in order for them to be effective from both a tax planning and a life planning perspective.

What is a SLAT?

A SLAT is an irrevocable trust that one spouse (the “settlor spouse” or “donor spouse”) creates for the benefit of the other spouse (the “beneficiary spouse”) (and sometimes, also for their issue) during that beneficiary spouse’s lifetime, and ultimately, at the beneficiary spouse’s death, the balance of the trust will pass in further trusts for issue. [10]  Effectively, the assets are on the other side of the tax fence, making use of the exemption before it drops, but still remain available (if needed) to provide for the lifestyle of the beneficiary spouse (and, if that beneficiary spouse so chooses, to provide for the lifestyle of the settlor spouse).[11]

When the concept is first introduced to clients, many ask “Does this really work?” or “Is this really legal?” as if this were some kind of trick.  That’s because clients generally view gifts to spouses (or trusts for their benefit) as qualifying for the marital deduction and not using the exemption.  The “trick” here is that SLATs do not qualify for the marital deduction.[12]

A SLAT is just an irrevocable trust that allows for discretionary distributions for the benefit of the beneficiary spouse (and perhaps descendants).  However, complexity can arise in determining the terms and provisions of the SLAT, as well as which assets should be used to fund it.  Much of that complexity comes from the potential application of the “reciprocal trust doctrine”, discussed in detail below.

Reciprocal Trust Doctrine

In order to get the benefit of 100% of the pre-sunset exemption amount, both spouses need to utilize their entire exemptions before the end of 2025.  In addition, in order to gain any benefit from using the pre-sunset exemption amounts at all, at least one spouse needs to use more exemption than he or she expects to have after the sunset, since the exemption is used from the “bottom up” (and not “top down”).  To illustrate this principle, consider the following scenarios (assuming a $14,000,000 exemption now and a $7,000,000 exemption after the sunset):

Scenario 1.  Each Spouse makes a $7,000,000 gift.

	Gift Amount	Remaining Exemption Prior to Sunset	Remaining Exemption After Sunset	Percentage of Exemption Used/Available After Sunset
Spouse 1	$7,000,000	$7,000,000	$0	50%
Spouse 2	$7,000,000	$7,000,000	$0	50%
Total	$14,000,000	$0	$0	50%

Under Scenario 1, no benefit would have been gained from the increased exemption amount if each spouse makes a $7,000,000 gift.  The total exemption used would be $14,000,000, and if the exemption is thereafter reduced by half to $7,000,000, both spouses would simply have used up his or her post-sunset exemption.  Nothing would have been gained – only 50% of the pre-sunset exemption amount would have benefitted the taxpayer’s family.

Scenario 2.  Spouse 1 makes a $14,000,000 gift and Spouse 2 doesn’t make a gift.

	Gift Amount	Remaining Exemption Prior to Sunset	Remaining Exemption After Sunset	Percentage of Combined Exemptions Used/Available After Sunset
Spouse 1	$14,000,000	$0	$0	100%
Spouse 2	$0	$14,000,000	$7,000,000	0%
Total	$14,000,000	$14,000,000	$7,000,000	75%

In Scenario 2, the taxpayers get the benefit of 75% of the pre-sunset exemption amounts, by having one spouse make a gift of the entire $14,000,000 exemption now and Spouse 2 not making any gifts.

Scenario 3.  Spouse 1 makes a $14,000,000 gift and Spouse 2 makes a $7,000,000 gift.

	Gift Amount	Remaining Exemption Prior to Sunset	Remaining Exemption After Sunset	Percentage of Combined Exemptions Available/Used After Sunset
Spouse 1	$14,000,000	$0	$0	100%
Spouse 2	$7,000,000	$7,000,000	$0	50%
Total	$21,000,000	$7,000,000	$0	75%

In this Scenario 3, the taxpayers get the benefit of 75% of pre-sunset exemption amounts, by Spouse 1 making a gift of the entire $14,000,000 exemption now and Spouse 2 making a gift of $7,000,000.  This is the same “percentage benefit” achieved in Scenario 2 where Spouse 1 makes a pre-sunset gift of $14,000,000 and Spouse 2 makes no gift.  That’s because in Scenario 2, Spouse 2 still has his or her $7,000,000 exemption that may be used going forward.  However, there is still benefit to Scenario 3 over Scenario 2.  As described above, the sooner a gift is made the more “leverage” results from the use of the exemption as (assuming assets increase in value over time) more than the dollar amount of the exemption gets to the other side of the tax fence.

Scenario 4.  Spouse 1 makes a $14,000,000 gift and Spouse 2 makes a $14,000,000 gift.

	Gift Amount	Remaining Exemption Prior to Sunset	Remaining Exemption After Sunset	Percentage of Combined Exemptions Used/Available After Sunset
Spouse 1	$14,000,000	$0	$0	100%
Spouse 2	$14,000,000	$0	$0	100%
Total	$28,000,000	$0	$0	100%

In Scenario 4, the taxpayers are clearly better off when both of them use their entire exemptions because they get the benefit of 100% of the pre-sunset exemption amounts.

Note that, as illustrated above, if a couple does not plan on using their combined pre-sunset $28,000,000 exemption, (1) fully utilizing one spouse’s exemption is better than using a portion of each spouse’s exemption and (2) the most benefit can be gained by utilizing one spouse’s entire exemption and at least half of the other spouse’s current exemption.  In the context of SLAT planning then, to maximize the tax savings from using their exemptions before losing them, Spouse 1 should create a SLAT for Spouse 2 and fund it with $14,000,000 and Spouse 2 should create a SLAT for Spouse 1 and fund it with $14,000,000.  However, when each spouse creates a SLAT for the other, the “reciprocal trust doctrine” will come into play and could eliminate all of the tax savings sought to be accomplished.  When Spouse 1 creates a SLAT for Spouse 2 and Spouse 2 creates a SLAT for Spouse 1, if both SLATs have identical terms (or even terms that are just too similar) and trustees, are funded with similar assets, and created at the same time, the IRS will have the opportunity to use the reciprocal trust doctrine in an attempt to defeat the plan.

Internal Revenue Code Section 2036 provides that if a person creates a trust for himself or herself, and retains the right to possess or enjoy the trust property or the income therefrom, the assets of the trust are included as part of the settlor’s estate and subject to estate tax at the settlor’s death.  Where spouses create substantially similar SLATs for each other, the IRS uses the reciprocal trust doctrine to “uncross” who the settlor of each SLAT is deemed to be for tax purposes.  In effect, the reciprocal trust doctrine would deem Spouse 1 to have created a trust for himself or herself and Spouse 2 to have created a trust for himself or herself, with the result being that and each trust would be included in the respective spouse’s taxable estate under Internal Revenue Code Section 2036.  Estate tax would be imposed on the trust assets at that time, and the tax advantages of creating the SLATs would be eliminated.

The Supreme Court’s decision in  U.S. v. Grace, 395 U.S. 316 (1969) is the best known case addressing the reciprocal trust doctrine.[13]  In Grace, the application of the reciprocal trust doctrine was found to hinge on two questions:  (a) do the trusts leave the parties in the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries and (b) are the trusts interrelated?[14]  If both questions were answered in the affirmative, the Grace Court said that the reciprocal trust doctrine would apply.

In Grace, each spouse created a trust for the other within a fifteen-day time period.  The terms of both trusts (which included (a) mandatory income to spouse, (b) principal to spouse as a majority of the trustees might deem advisable and (c) a testamentary limited power of appointment exercisable in favor of the donor spouse and children) were nearly identical and the trusts were created as part of a single transaction.  The Court also noted that the trust created by wife was even funded with assets husband had transferred to her over the years.  Based on these facts, Grace found that both questions were answered in the affirmative – the creation of the trusts was interrelated, and both spouses were in the same economic position as if each had created a trust for themselves.  Therefore, the Supreme Court held that the reciprocal trust doctrine applied.  The trusts were “uncrossed”[15] and the trust created by wife was included in the taxable estate of the husband.

Unfortunately, there is no regulation or case that clearly sets forth how different SLATs must be to avoid the application of the reciprocal trust doctrine.  In the cases that followed Grace, the courts have analyzed a number of factors, such as, (a) the date of creation of the trusts, (b) the terms of the trusts, (c) the trustees, (d) the assets used to fund the trusts and (e) the beneficiaries.

For example, in Krause v. Commissioner, 57 TC 890 (1972) the Tax Court held that the reciprocal trust doctrine was applicable where the six trusts at issue were created on the same day, named the same trustees, included each spouse as a beneficiary and contained identical provisions (except the trusts husband created were for children and wife, and the trusts wife created were for grandchildren and husband).  The trusts were interrelated and left the spouses in the same economic position they would have been in had they created the trusts for themselves.  Both parts of the Grace test were answered in the affirmative, and the reciprocal doctrine was found to apply.

Levy v. Commissioner, T.C. Memo 1983-453 is the only case which actually provides a clue as to what provisions might be utilized to avoid the application of the reciprocal trust doctrine.  In Levy, husband and wife each created a trust for the other.  Each trust was funded with identical closely held business interests  The trusts were created and funded at the same time, and each spouse acted as trustee of the trust created by the other.  There was one difference between the two trusts; one granted the beneficiary spouse a limited power of appointment exercisable during life, while the other trust did not grant the beneficiary spouse that same limited power of appointment.  In terms of the Grace factors, the trusts were clearly interrelated so the second Grace question was answered “yes”.  However, because one spouse could access the assets of one trust using the limited power and the other spouse could not so access the assets of the other trust, each spouse was not found to be in the same economic position as if each had created the other trust for his or her benefit.  This was enough of a difference for the Tax Court to conclude in Levy that the reciprocal trust doctrine could not be applied to defeat the tax plan.

Levy is one Tax Court memorandum decision which is 40 years old.  Most practitioners who draft SLATs for both spouses do not rely simply on the Levy decision and include a power of appointment in one trust and not the other to avoid the application of the reciprocal trust doctrine.  Instead, some practitioners may consider some or all of the following factors when they create two SLATs and try to differentiate them in order to avoid the assertion of the reciprocal trust doctrine to defeat the tax plan:

• Timing of creation – Consider creating and contributing to SLATs at different times to avoid the Grace “interrelated” factor.  One spouse may create a SLAT in 2024 and the other spouse may create a SLAT in 2025.  The closer we are to the sunset, the more difficult it becomes to use this factor to avoid the application of the reciprocal trust doctrine.  Some practitioners may be concerned that for couples who created one SLAT in 2012, the IRS might argue that creating a SLAT for the other spouse now might not avoid the application of the reciprocal trust doctrine if gifts to both SLATs are made concurrently today.  Thus, practitioners may still consider differentiating the SLATs in other ways as well.
• Assets contributed – Donors might contribute different assets to the SLATs, again in order to reduce the risk of the interrelated factor in Grace.  This can often be difficult to accomplish as donors want to make gifts of assets that they believe will appreciate most in value, or clients may simply not have a diverse bundle of assets (e.g., when most of both spouse’s estates are comprised of interests in a closely held business).

For example, a couple may have identified the stock of their family business as that asset – and in that circumstance, there may be only one asset to gift to get the optimum amount on the other side of the tax fence.  However, Spouse 1 could give stock in the family business to a SLAT for Spouse 2, while Spouse 2 gives bonds to a SLAT for Spouse 1.  After some time, the SLAT created for Spouse 2 could swap those bonds for an interest in the family business still owned by Spouse 2.[16]

Aside from the fact that appreciation in the value of the stock in the family business might have taken place between the date of the gift to fund the SLAT for Spouse 1 and the date that the SLAT for Spouse 2 swaps the bonds for the interest in the family business (presenting a missed opportunity to move appreciation) and that a second appraisal of the stock in the family business would be required for the swap (adding cost and aggravation to the plan), IRS might still seek to apply the reciprocal trust doctrine by asserting that the swap was a prearranged plan and that effectively the two SLATs were funded with the same assets.[17]  This is why there is no assured answer to any of this, but in these circumstances many practitioners may rely on material drafting differences between the two SLATs that do not leave each spouse in the same economic position.

• Trustee selection – Making the trustee provisions of each SLAT different may also make the trusts seem less interrelated, although as with all aspects of the reciprocal trust doctrine, there is no certainty.  This is an aspect of the SLATs that can be made distinct without too much effort.  One SLAT can have a sole trustee, while the other can have co-trustees.  Different people can be named to serve in those roles.  After one spouse dies the children can become co-trustees or sole trustees at different ages in each SLAT.  The more different the trustee provisions can be, the more chance there may be to avoid the reciprocal trust doctrine.  Different provisions regarding powers to remove and replace trustees can be added to the documents, further showing that the two SLATs are not identical.
• Distribution provisions – Consider varying the distribution provisions in the SLATs.  This can help avoid both the interrelated and same economic position factors of Grace.  One SLAT may prohibit distributions for a specific number of years after creation, or until a certain event occurs, while the other permits discretionary distributions immediately upon creation, or, maybe one SLAT has an ascertainable standard while the other does not (tax considerations in using an ascertainable standard are discussed further below).  Another SLAT may put limits on the amounts that may be distributed in any one year.  Or, one SLAT may call for all the trust income to be distributed annually, while the other would only call for discretionary distributions.[18]  These differences in distribution provisions are helpful in showing that the spouses are not in the same economic position and, therefore, avoid that part of the Grace test and the successful application of the reciprocal trust doctrine.
• Beneficiaries – This is a place where careful attention might be paid in order to endeavor to make the SLATs different enough to avoid the reciprocal trust doctrine.  Recall that Grace would apply the reciprocal trust doctrine where the parties (here, the two spouses) have the same economic interests as if they had each created a trust for himself or herself.  If the beneficial – i.e., economic – interests can be made different enough, a successful application of the reciprocal trust doctrine by the IRS may be more challenging.  It is important to remember, however, there is no bright line test as to what differences are “enough”, and practitioners might consider cautioning clients in writing about this uncertainty.

For example, SLAT-1 could be created for spouse and issue while SLAT-2 could be created for just spouse or spouse and charity during the spouse’s lifetime.[19]  Another option might be to create SLAT-1 for spouse and SLAT-2 (referred to below as a “Hidden SLAT”) for the benefit of only issue.[20]  In that circumstance, SLAT-2 could also include provisions that allow for the appointment of special power holder, who is an independent person, at some time in the future with the power (acting in an expressly non-fiduciary capacity) to add beneficiaries to SLAT-2 from the class composed of the issue of the SLAT-1 settlor’s parents.  If the Hidden SLAT approach is used, and the couple never needs funds from SLAT-1 or the Hidden SLAT, when one spouse dies there arguably is nothing for IRS to “uncross”; there is simply one trust for a spouse and another for issue, the reciprocal trust doctrine arguably should not apply.  But, if the couple exhausts their funds outside SLAT-1 and the Hidden SLAT, the spouse who is beneficiary of SLAT-1 can receive discretionary distributions from SLAT-1 to provide for that spouse’s lifestyle (and the lifestyle of the donor spouse should the beneficiary spouse permit).  If the first spouse dies during that period, again there is only SLAT-1 for spouse and the Hidden SLAT for issue – and arguably nothing for IRS to uncross.  Now, assume that the couple spends SLAT-1 completely and needs money from the Hidden SLAT to maintain their lifestyles.  The Trust Protector is appointed, and the non- donor spouse is added as a trust beneficiary of SLAT-2.  Thereafter, that added spouse draws down on SLAT-2 (that used to be the Hidden SLAT) to provide for that spouse’s lifestyle (and the lifestyle of the donor spouse should the beneficiary spouse permit).  When a spouse dies, there is only SLAT-2 (SLAT-1 having been consumed), so again nothing for the IRS to uncross.  Practitioners should consider that the IRS might challenge the plan on the mere existence of the ability to add the non- donor spouse as a beneficiary.

A variation on the Hidden SLAT technique that could put the couple in a similar position would be if SLAT-1 was for spouse but SLAT-2 was for children, with SLAT-2 becoming a trust for the other spouse pursuant to the terms of SLAT-2 after the first spouse dies (this could be called a “Springing SLAT”).[21]  Again, if IRS audits on the first death, when both spouses were alive there was only SLAT-1 for spouse and SLAT-2 for children – there may arguably be nothing to uncross.

Bischoff v. Commissioner, 69 T.C. 32 (1977) was a case that involved a husband and wife creating identical trusts for their grandchildren (neither spouse was named as beneficiary of the two trusts).  In that case, the Tax Court found that the reciprocal trust doctrine applied – which could give concern that the SLAT/Hidden SLAT approach may not avoid the application of that doctrine at all.[22]  However, the conclusion of the Tax Court in Bischoff was rejected by Green v. US, 68 F.3d 151 (6^th Cir. 1995), which held that the Grace doctrine requires interrelated trusts to provide a “retained economic benefit.”[23]  Applying the Circuit Court’s interpretation in Green, if SLAT-2 does not name the spouse as a current beneficiary, IRS could not cause inclusion under Section 2036 because the spouses were not in the same economic position after creation of the trust as they were before.

There could be additional differences in the dispositive provisions that could help avoid the application of the reciprocal trust doctrine.  One SLAT, for example, might provide for 10% of the assets to be retained for grandchildren with the balance to be kept in trust for children after the settlor’s spouse dies, and the other SLAT could provide that the assets are all for the children in that circumstance.  Or there could be different ages where certain portions of the SLATs are distributed to remainder beneficiaries, either outright or in trust.[24]  Another approach would be for one SLAT to call for assets for remainder beneficiaries to be for children only, while the other creates “sprinkle trusts” for children and issue after the settlor’s spouse passes.  Though different remainder beneficiaries may not avoid the Grace holding that the spouses aren’t in different economic positions, having different remainder beneficiaries does make the SLATs look more unlike each other to support the argument that the reciprocal trust doctrine is inapplicable because the trusts are not interrelated.

• Powers of appointment – Providing different powers of appointment for the spouse beneficiary of each SLAT may also help avoid the reciprocal trust doctrine by putting the spouses in different economic positions.  For example, as in Levy, SLAT-1 might give the beneficiary spouse a lifetime limited power of appointment in favor of issue or charity[25], and SLAT-2 might have no power of appointment.  Alternatively, SLAT-1 might permit the beneficiary spouse to exercise a limited power of appointment at death over the trust assets amongst the donor spouse’s issue, while SLAT-2 might not give the beneficiary spouse any power of appointment.  Having the right to direct or not direct disposition of assets arguably puts the spouses in different economic positions (and may cause the trusts to not be interrelated), which according to Grace and Levy could help avoid the application of the reciprocal trust doctrine, but as discussed above, practitioners may choose not to rely on just this one difference alone.
• Different administrative provisions – Thought could be given to having different administrative provisions in each SLAT, in order to avoid the application of the reciprocal trust doctrine.  For example, SLAT-1 could allow for investment in only growth assets, while SLAT-2 could allow for investment in only bonds.[26]  A beneficiary of a trust that can invest for growth is arguably in a different economic position than one who is beneficiary of a trust that can invest only in bonds – and these different provisions may also allow the SLATs to appear less interrelated.  Similarly, including provisions that provide different circumstances where each spouse can borrow from the SLAT the other established for him or her could put the spouses in different economic positions.  Provisions that allow (or don’t allow) flexibility in allocating income and expense between income and principal could, again, put the spouses in different economic positions.[27]

SLAT Distribution Standards

When establishing SLATs, the settlors might consider planning to receive distributions only if they consume all of their assets outside the SLATs to provide for their lifestyles.  That’s because assets outside the SLATs will be subject to estate tax (assuming all exemption has been used) when those assets pass to their heirs, while assets inside the SLATs avoid that tax (and, if created in dynastic form, by using the settlor’s GST exemption can avoid transfer taxes for future generations).  In essence, the dollars inside the SLAT are “100 cent dollars” for the children, grandchildren or other beneficiaries, but dollars outside the SLAT are “60 cent dollars” for those heirs.  Parents clearly should spend the 60 cent dollars first.

That said, the reason for establishing SLATs in the first place is to have access to SLAT assets if the clients’ assets outside the SLAT are consumed.  Therefore, the SLATs should provide for some form of distribution to the beneficiary spouse.

A discussion of the possible distribution standards that a SLAT might include appears below:

• Mandatory distributions – As mentioned earlier, a SLAT could include mandatory distributions to the beneficiary spouse.  However, the purpose of a SLAT is to allow the assets to accumulate inside of the SLAT and outside of the beneficiary spouse’s estate, so to the extent the beneficiary spouse does not need a distribution, it is most tax efficient to leave the assets in the SLAT.  Again, if the mandatory distribution is a mandatory income distribution (as opposed to a fixed dollar amount or percentage), there are ways to manipulate the SLAT’s income in order to preserve more the assets in the SLAT.[28]  Practitioners and clients may also want to consider the loss of asset protection with respect to the mandatory distributions.
• Absolute discretion – An absolute discretion standard is one that is not limited by an ascertainable standard.  Typically, such standard allows the trustee to make distributions in the “best interests” of the SLAT beneficiaries, or “as the Trustee determines in the Trustee’s sole and absolute discretion”.  However, if an absolute discretion standard is chosen, the beneficiary spouse cannot participate in those distribution decisions (for example, as trustee or co–trustee) without adverse tax consequences.

Pursuant to Internal Revenue Code Section 2514, a beneficiary who is also a trustee of the trust possesses a power of appointment if that person may distribute principal to himself or herself.[29]  Section 2041(b)(1) of the Internal Revenue Code provides, “The term “general power of appointment” means a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate” except if such power is limited by an ascertainable standard.  Section 2041(a)(2) of the Code provides, in pertinent part, that “The value of the gross estate shall include the value of all property [t]o the extent of any property with respect to which the decedent has at the time of his death a general power of appointment created after October 21, 1942…”  Thus, a beneficiary acting as trustee with the power (even if that power is only exercisable with another) to distribute principal to himself or herself that is not limited by an ascertainable standard is a general power of appointment, which causes estate tax inclusion in the beneficiary’s estate.

Further, if the beneficiary acting as trustee were to exercise this power to make distributions in the trustee’s absolute discretion in favor of another, that exercise would be treated as a taxable gift by the beneficiary.[30]  By exercising that power, the beneficiary spouse acting as trustee is diverting assets to another, and that diversion of assets pursuant to a power not limited by an ascertainable standard results in the beneficiary spouse making a taxable gift.[31]

If the beneficiary spouse is the beneficiary of a SLAT with an absolute discretion standard, he or she will need to rely on the discretion of another to gain access to SLAT assets if needed in the future.[32]  When contemplating the creation of a SLAT, a client may not be comfortable relying on another’s discretion.  However, if the donor spouse (or, after the donor spouse’s death, the beneficiary spouse) has the power to remove and replace the trustee, that spouse always has the option of “firing” a trustee who won’t make a requested distribution and replacing that trustee with one who will make that distribution.  To avoid estate tax inclusion under Section 2041 of the Code when including this power to remove and replace trustees, the donor spouse and the beneficiary spouse should be prohibited from appointing a trustee who is a “related or subordinate party” as defined in IRC Section 672(c).  In most cases, this power to remove and replace trustees can help clients get comfortable that SLAT assets, if needed, will be available to the beneficiary spouse.

• Ascertainable standards – As discussed above, a beneficiary who is also a trustee (a “beneficiary-trustee”) may not participate in distribution decisions pursuant to a fully discretionary (absolute discretion) standard without causing adverse tax issues (whether those are gift tax issues or estate tax issues or both depends on the terms of the trust).  However, the beneficiary-trustee will not be subject to adverse estate or gift tax consequences if that beneficiary-trustee’s distribution power is limited to an ascertainable standard.[33]  An example of an ascertainable standard is “health, education, maintenance and support.”  However, even where an ascertainable standard is employed, there is the risk of estate tax inclusion if not structured properly.

Internal Revenue Code Section 2036(a)(1) provides, in pertinent part, that the decedent’s gross estate “shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death the possession or enjoyment of, or the right to the income from, the property.”  Treasury Regulations Section 20.2036-1(b)(2) provides, in pertinent part, that “[t]he “use, possession, right to the income, or other enjoyment of the transferred property” is considered as having been retained by or reserved to the decedent to the extent that the use, possession, right to the income, or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent, or otherwise for his pecuniary benefit.  The term ‘legal obligation’ includes a legal obligation to support a dependent during the decedent’s lifetime.”

Spouses have a legal obligation to provide for each other’s support.  If a SLAT provides that the trustees shall distribute assets from the SLAT to the beneficiary spouse for his or her health, education, maintenance and support, the SLAT will be included in the donor spouse’s taxable  estate pursuant to Section 2036(a)(1).[34]  This is the result no matter who is acting as trustee of the SLAT.

The more difficult question is what happens when the trustees may (as opposed to shall) make distributions from the SLAT for the beneficiary spouse’s for health, education, maintenance and support?  The answer depends on who is acting as trustee of the SLAT.

In Sullivan v. Commissioner, 66 T.C. Memo 1329 (1993), the decedent created a trust for his spouse which directed the income be paid to the beneficiary spouse and principal paid to her “as the Trustees, in the exercise of their discretion, may deem necessary or advisable from time to time to provide for her proper care, support, maintenance and health, taking into consideration her needs and the other sources of financial assistance, if any, which may be or may become available for such purposes.”  This was an ascertainable, may standard. The donor spouse was a trustee of the trust.  The Tax Court held the trust was included in the decedent’s estate under Internal Revenue Code Section 2036(a)(1).  “The likelihood that decedent would actually use the trust funds to satisfy his support obligations is irrelevant. If the decedent, as trustee, has the power to discharge his legal obligations [to support his spouse], that power triggers the applicability of section 2036(a)(1). [citations omitted].  Section 2036(a)(1) does not require that the transferor pull the “string” or even intend to pull the string on the transferred property; all that is required is that the string exist. [citations omitted]”.[35]

The Tax Court reached a similar holding in McTighe v. Commissioner, T.C. Memo 1977-410 (1977).  The Tax Court addressed a trust where the settlor had reserved a power to remove and replace trustees, and could appoint himself to act as trustee.  The distribution standard found in the trust instrument permitted payment for the support, maintenance or education of decedent’s son as the trustee deemed “necessary and advisable”.  The court found that the settlor had the legal obligation to support his child, and although the ascertainable standard in effect was a may standard, just the possibility that the settlor could become the trustee who could make such determination and distribution was enough for the court to find that the trust was included in his estate under Section 2036(a)(1) of the Internal Revenue Code.

Contrast McTighe and Sullivan to Commissioner v. Douglass, 143 F.2d 961 (3d Cir. 1944).  In Douglass, a trust was established by settlor for all of his children – including a minor child.  The trust allowed the trustees to apply the income of the minor’s share, to the extent that the trustees deemed advisable, for the maintenance, education and support of the minor.  This is an ascertainable, may standard.  Decedent settlor was not acting as trustee of the trust.  The IRS sought to include the value of the minor’s share of the trust in decedent’s taxable estate, but the Tax Court denied it and the Third Circuit affirmed.  In its decision, the Third Circuit noted that the regulation relied upon by IRS in arguing inclusion in the decedent’s estate includes the words “is to be applied” (a shall ascertainable standard), and that those words did not mean the same thing as the words “may be applied” (a may ascertainable standard).  Because the trust at issue had a may ascertainable standard, the court concluded that the trust would not be included in the decedent’s estate.

Mitchell v. Commissioner, 55 T.C. 576 (1970) is another case that can provide some insight into how the different distribution standards applicable in the SLAT context impact estate tax inclusion where the settlor is not acting as trustee of the trust.  In Mitchell, decedent created a trust for spouse.  Son was the trustee.  The terms of the trust provided that the trustees “shall pay” to decedent’s spouse such amounts of income and principal as the trustee, in his “unrestricted discretion” determined to be necessary for the donor spouse’s comfortable support and maintenance, taking into consideration her other sources of income.  This appears to be a shall ascertainable standard, but the Tax Court found that because the discretion to make distributions was held by an independent trustee (the son was treated as independent by the court) who had the “unrestricted discretion” to decide upon distributions, in reality this was a may ascertainable standard.  Therefore, the trust assets were not included as part of the settlor’s estate.

Summarizing the above, there are two instances where Internal Revenue Code Section 2036(a)(1) may cause inclusion of a SLAT in the donor spouse’s taxable estate because the SLAT was created to satisfy the settlor’s legal obligation to support his or her spouse:  first, where the SLAT provides that the trustees shall make distributions for the beneficiary spouse’s health, education, maintenance and support and, second, where the donor spouse acts as trustee (or may become trustee) and the trustees may make distributions for the beneficiary spouse’s health, education, maintenance and support.[36]

There is some specific language that could be included in a SLAT to avoid these issues if an ascertainable standard is to be employed.  The SLAT could prohibit distributions that would satisfy the Settlor’s obligation to support any person during the Settlor’s lifetime, even if made pursuant to an ascertainable standard.  The ascertainable standard could be a may standard rather than a shall standard.  And the terms of the SLAT could prohibit the Settlor from acting as trustee.

Who Should Act as Trustee of a SLAT?

When selecting a trustee of a SLAT, clients typically want to pick one (or more) of the following:  (1) the donor spouse; (2) the beneficiary spouse; (3) a child; or (4) an independent trustee.  The general rules are:

• The donor spouse should not serve as a trustee of a SLAT.
• The beneficiary spouse may (a) serve as a trustee of a SLAT which uses a may ascertainable standard or (b) serve as a co-trustee of a SLAT that uses an absolute discretion standard, so long as the beneficiary spouse does not participate in distribution decisions.
• A child (a) who is not a current or remainder beneficiary may serve as a trustee of a SLAT with no restrictions, (b) who is a current or remainder beneficiary may (i) serve as a trustee of a SLAT which uses a may ascertainable standard or (ii) serve as a co-trustee of a SLAT that uses an absolute discretion standard, so long as the child does not participate in distribution decisions.
• An independent trustee can always serve as a trustee of a SLAT.

Determining who can be a Trustee requires a thorough analysis that takes into consideration the distribution standard analysis discussed earlier in this article.  The analysis below discusses how these general rules should be applied in a specific context:

• Donor spouse –  As a general rule, the donor spouse should not serve as a trustee of a SLAT.  Treas. Reg. Section 25.2511-2(c) provides, in pertinent part, that a gift is incomplete if and to the extent that a reserved power gives the donor the power to “change in the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard.”  Thus, if the donor spouse serves as trustee with the power to make distributions that are not limited by an ascertainable standard (see above for a discussion on distribution standards), the gift to the SLAT would be incomplete and the donor spouse would have failed to use his exemption.  In addition, as discussed above, a donor spouse cannot act as a trustee of a SLAT which contains an ascertainable standard as that could cause estate tax inclusion under Internal Revenue Code Section 2036(a)(1).[37]
• Beneficiary spouse – The beneficiary spouse may serve as a trustee of the SLAT.  The beneficiary spouse should not serve as sole trustee if distributions are permitted pursuant to an absolute discretion standard.  The beneficiary spouse may serve as a co-trustee where an absolute discretion standard is employed in order to participate in investment decisions, but he or she should be prohibited from taking part in distribution decisions.[38]  When an ascertainable standard is used, the beneficiary spouse can serve as a trustee, but be mindful of the inclusion issues discussed above with respect to the donor spouse’s support obligation – a may ascertainable standard could be used instead of a shall ascertainable standard to reduce the risk of inclusion.  Perhaps the most conservative approach is to appoint an independent trustee to act while the donor spouse is alive and provide that independent trustee with an absolute discretion standard  and, after the donor spouse dies, allowing the beneficiary spouse to become trustee with an ascertainable standard for distributions.  Once the donor spouse dies, his or her legal obligation to support the beneficiary spouse ceases to exist.  Therefore, giving the beneficiary spouse (after the donor spouse’s death) the right to distribute to himself or herself as trustee subject to an ascertainable standard results in no risk of inclusion in the beneficiary spouse’s estate (the ascertainable standard is a limited power of appointment).
• Child – A child of the donor spouse may serve as a trustee of the SLAT.  However, if the child is a current or remainder beneficiary of the SLAT, the trust must be structured to avoid the estate inclusion and gift issues discussed above with respect to the beneficiary spouse, as the same analysis would be applicable to a child beneficiary serving as trustee.  Specifically, the power to make payments to the beneficiary spouse and the child trustee should be limited by a may ascertainable standard.  This avoids a taxable gift if the child beneficiary makes a payment to the beneficiary spouse (because the payment is made pursuant to an ascertainable standard), and it also avoids estate tax inclusion in the settlor spouse’s estate (because it is a may ascertainable standard).
• Independent Trustee – An independent trustee will have the most flexibility to make distributions from a SLAT, and an independent trustee will be required in order to make distributions from a SLAT pursuant to an absolute discretion standard.[39]  In addition, an independent trustee can help differentiate a SLAT in a reciprocal trust analysis if SLAT-1 and SLAT-2 name different trustees.  As discussed above, the donor spouse (and then, if desired, the beneficiary spouse) should retain the right to remove and replace the independent trustee in order to maintain control over the SLAT.

How Does Surviving Spouse Have Enough Assets When First Spouse to Die’s SLAT Passes to Issue?

When creating a SLAT, the donor spouse retains indirect access to the trust assets through the beneficiary spouse.  This access is lost upon the death of the beneficiary spouse.  If the beneficiary spouse dies and SLAT-1 terminates and distributes to trusts for children, the terms of those trusts for children may include a provision which gives the trustees the power to lend to the donor spouse.  That way, the donor spouse will still have the ability to borrow from the children’s trusts if necessary[40], but access to the SLAT’s assets by being married to and relying on the beneficiary spouse to receive distributions from the SLAT and use those assets to support himself or herself and his or her spouse will no longer be available.[41]

Another option to deal with this concern is to purchase life insurance on the spouse expected to die first, in order to “replace” SLAT assets which pass to issue on the first beneficiary spouse’s death.  For example, the SLAT created by husband for wife can also own a life insurance policy on husband.  Then, when husband dies and the SLAT created for husband by wife terminates and assets pass to trusts for issue, the SLAT still in force for wife receives the insurance proceeds on husband’s life to replace the assets of the SLAT that terminated to provide for wife’s support.[42]

 

How Does the Possibility of Divorce Impact SLAT Planning?

If husband creates a SLAT for wife, and then the couple divorces, clearly the assets of that SLAT created by husband will not be available in the future to provide for husband’s benefit.[43]  When that divorcing couple divides assets in this circumstance, wife starts out “ahead” because the assets in the SLAT for her created by husband are not part of the marital assets subject to division.  In that circumstance, some couples consider a post-nuptial agreement (which, in some states, may be subject to heightened scrutiny) that indicates if divorce were to occur that the SLAT assets would count as part of the marital assets that were awarded to wife when the division of actual assets that remain to be divided is completed, so that husband doesn’t start the process “behind” the wife.  Others include provisions in their SLATs that deem a beneficiary spouse to be dead if divorce were to occur; in that circumstance, the assets in the SLAT husband created for wife immediately are held for the benefit of issue – leaving neither member of the couple “ahead” when it comes to the division of the marital assets.[44]

Where husband and wife create SLATs for each other (which are non-reciprocal) funded with assets of the same value, then upon divorce if the SLATs stay in existence neither spouse is really “ahead” when it comes to the division of marital assets.  In that circumstance, however, the provision that if the couple divorces they are treated as dead so that SLAT assets pass immediately for children might not be part of the SLAT provisions.  In that circumstance, if the SLAT assets constitute a large portion of what would otherwise be the assets of the marital estate to be divided, the effect would be that husband and wife would not have sufficient assets to acquire through division of the marital estate to provide for their future needs.[45]

If the SLAT/Hidden SLAT approach were taken, upon divorce the Trust Protector could be appointed to name the non-donor spouse as beneficiary of the Hidden SLAT.  Then, the couple is in the same position as if they’d each created SLATs for each other, and no one would be “ahead” when the marital assets are divided.[46]  But if the SLAT/Springing SLAT approach were taken, then one spouse would be “ahead” of the other because the beneficiary spouse of the Springing SLAT would not become a beneficiary until the donor spouse’s death.  In order to protect the beneficiary spouse of a Springing SLAT, it may make sense to instead provide that the beneficiary spouse becomes a beneficiary on the earlier of (a) divorce or (b) the donor spouse’s death.  Again, it is presumed that after the divorce the reciprocal trust doctrine is not an issue.

All of these possibilities can be specifically discussed with clients whether they create one SLAT or two.  The option to speak to separate counsel as part of the SLAT plan could be suggested to the couple.  Some attorneys, particularly where only one SLAT is being created for one spouse, may prefer their clients to speak to separate counsel before putting the plan in place.  Although, many clients will not be willing to consult with separate counsel, best practice might be to keep a record of the fact that the suggestion was made to do so.

SLATs are Grantor Trusts

Another factor that is important to note in SLAT planning is that a SLAT is a grantor trust.[47]  For many, a grantor trust is helpful estate tax planning tool.  The donor spouse can pay such income tax from future estate-taxable assets, rather than from the non-estate-taxable SLAT assets – effectively making a transfer of the tax payment to the SLAT out of the donor’s taxable estate without gift tax consequence.  However, for those that create SLATs because of a fear of running out of money, the income tax liability resulting from the SLAT may be a burden.[48]  The SLAT should include an income tax reimbursement provision which allows an independent trustee to reimburse the donor spouse for his or her income tax liability associated with the SLAT.[49]  This provision should be used conservatively and not appear to be relied on every year.  In years where the reimbursement right will not be used to provide the donor spouse with funds to pay his or her income tax on SLAT assets, the donor spouse may instead borrow funds from the SLAT to pay the income taxes, or the beneficiary spouse may even take distributions from the SLAT to give to the donor spouse to use in making tax payments.

In the context of divorce, the SLATs that each spouse created for the other will continue to be grantor trusts.  This means that if husband created a SLAT for wife, husband continues to be taxed on the income earned by wife’s SLAT that she enjoys even after a divorce, much to husband’s dismay (and vice versa).  For that reason, where only one spouse creates a SLAT for the other, a post-nuptial agreement might be entered into obligating the beneficiary spouse to reimburse the donor spouse for income taxes paid post-divorce on SLAT income.[50]  And if both spouses created SLATs for the other, after divorce both will have to pay income tax on the income earned that benefits the other.  No one is happy in that situation, and it is a point that might be negotiated as part of any marital settlement agreement.  One approach that the parties might find agreeable is to calculate their income with and without taking into account SLAT income, and to “true up” the difference each year.[51]

Funding a SLAT

A SLAT must be funded with the donor spouse’s assets (and not assets from a joint account).  In a community property state, the property must be the donor spouse’s separate property.  If joint assets or community property are used to fund a SLAT, the beneficiary spouse will be deemed to have made a transfer to the SLAT of a portion of the assets used to fund the SLAT and retained the right to possess or enjoy the property transferred or the income therefrom – causing estate tax inclusion of a portion of the SLAT in the beneficiary spouse’s taxable estate under Internal Revenue Code Section 2036.

It is important for the clients to identify the assets that will be used to fund the SLATs in advance.  It is possible that assets may need to be reallocated or transmuted by agreement prior to the SLAT funding.[52]

The SLAT could be viewed as a last resort “safety net” for the clients.[53]  When evaluating target assets for a gift to a SLAT, clients could consider funding, to the extent feasible, with non-income producing assets so that there is little or no noticeable lifestyle change after the gift is made.[54]  In reality, however, many clients seeking to use exemption will not have sufficient assets to accomplish this.

Often times, non-controlling interests in property are used to make gifts in order to reduce the value of the gifted assets as a result of discounts for lack of control or lack of marketability.  For example, if a couple wants to gift an interest in an entity to trusts for children, the husband might give a 50% interest in that entity to a trust he creates for children using discounts, while wife might give a 50% interest in that entity to another trust that she creates for the children using discounts.[55]  Remember, that in the context of SLATs funding two SLATs with similar assets increases the risk that the reciprocal trust doctrine can be used to defeat the tax plan.  Therefore, non-controlling interests in different entities would be a better choice to consider in funding SLATs, if the client’s assets permit that.

Conclusion

As we approach the sunset of the increase in the exemption permitted by the TCJA, SLAT planning[56] will again be an important option for those clients who know they should use their exemptions before they lose them but are worried that, if they do, they may run out of money to support their own lifestyles.  Proper SLAT planning can allay the fears of these clients and help them accomplish the tax savings available from using their exemptions before they are potentially cut in half in 2026.

It is important that clients consider engaging in this planning now in order to reduce potential challenges by the IRS.  The longer clients wait, the more challenging it may be for SLATs to be differentiated, and, if clients wait until after the election or until 2025, the opportunity for Spouse 1 to create a SLAT in 2024 and for Spouse 2 to create a SLAT in 2025 will be lost.

Even if SLAT planning is undertaken and the exemption does not fall, there is no tax planning downside.  Assuming that assets appreciate in value after contribution to a SLAT, using the exemption sooner rather than waiting until death leverages the benefits of the exemption for taxpayers.  In that sense, SLAT planning is truly a “no harm, no foul” technique.

*Andrew M. Katzenstein is a partner in the Private Client Services Department in the Los Angeles office of Proskauer Rose LLP where he assists high net worth individuals, companies and charitable organizations with all aspects of tax and estate planning. Andy focuses his practice on tax planning matters, which include estate, gift and generation-skipping tax planning, as well as income tax of trust planning, probate and trust administration matters, resolving disputes between fiduciaries and beneficiaries, and charitable planning.

Caroline Q. Robbins is a partner in the Private Client Services Department in the Los Angeles office of Proskauer Rose LLP.  Cary provides sophisticated estate and tax planning advice to individuals and families, with an emphasis on the multigenerational transfer of wealth.  She works with clients from a variety of backgrounds, including real estate investors, entrepreneurs, business owners, private equity principals, and individuals with inherited wealth.  She also routinely counsels clients on their charitable giving and assists clients with the formation and administration of private foundations to meet their charitable goals.

Andrew M. Katzenstein Proskauer Rose LLP 2029 Century Park East, Suite 2400 Los Angeles, CA 90067 310-284-4553 akatzenstein@proskauer.com

Caroline Q. Robbins Proskauer Rose LLP 2029 Century Park East, Suite 2400 Los Angeles, CA 90067 310-284-4546 crobbins@proskauer.com

[1] The GST exemption currently matches the estate tax exemption and is also set to sunset at the end of 2025.  Though this article focuses on using the estate tax exemption before it is scheduled to sunset in 2025, the same attention should be focused on using the GST exemption before it drops in 2025 as well.  In that regard, if a client has a trust with an inclusion ratio of one, thought should be given to making a late GST allocation in order to make that trust have an inclusion ratio of zero, or, if a client has a trust with “mixed” inclusion ratios, thought should be given to allocating GST exemptions to those trusts so that all trusts have inclusion ratios of either zero (exempt from the GST) or one (subject to the GST).

[2] There have been several proposals (none of which have been enacted to date) to restriction generational planning.

[3] The amount that could pass free of estate tax in 1981 was $175,625.  The Economic Recovery and Tax Act applicable in 1982 more than tripled the amount of the exemption to $600,000.

[4] Inflation adjustment added to the law in 2011.  Thereafter, the exemption increased each year due to inflation.

[5] Under the TCJA, the exemption increased to $10,000,000, adjusted for inflation , which is why the exemption in 2018 jumped to $11,180,000.  Inflation adjustment has driven the amount of the exemption to $13,610,000 in 2024.  In 2025, the amount is expected to be about $14,200,000.

[6] The authors suspect that when wealthy Senators were faced with actually voting to reduce the amount of the exemption and increase estate taxes on their own estates, that they succumbed to self-interest.

[7] Since the exemptions can be inconsequential for billionaires and other very high net worth clients, much more substantial planning is necessary, and there are many techniques available fo this purpose.

[8] Of course, life expectancy also played into a person’s comfort in making such gifts.  A 90 year old wouldn’t need as much to live out his or her life as a 40 year old would need.

[9] Practitioners may consider advising clients that the future of the exemption is unknown and engaging in a thoughtful analysis on the risks and benefits of exemption planning.

[10] As will be discussed in this article, the SLAT technique can be utilized by a married couple.  For an unmarried client who is looking to utilize his or her exemption but maintain potential access to the assets, he or she should consider creating a trust of which he or she is included in the discretionary class of beneficiaries.  This kind of trust must be created in a state with asset protection statutes in order to avoid estate tax inclusion.  This type of trust is outside of the scope of this article.

[11] Note that there should not be an implied agreement to use the money in the SLAT, and if distributions are made regularity, the IRS may argue there was an implied agreement.

[12] Generally, when one thinks about a trust one spouse creates for the other spouse, one thinks about a QTIP trust that can qualify for the marital deduction with the proper election.  However, a SLAT is specifically structured to not qualify for the marital deduction in order to utilize the donor spouse’s exemption.  Contrasted with a QTIP trust, a SLAT does not frequently require mandatory income payments to the beneficiary spouse.  Of course, a QTIP trust could also be used as long as no marital deduction election is made on the federal gift tax return (Form 709) reporting the gift to that trust.  A QTIP trust could even provide additional flexibility for those clients who are undecided about using their exemptions now as a gift to a QTIP trust in 2025 would give the taxpayer until October 15, 2026 to make a decision to elect to qualify that gift for the marital deduction (thus, not using exemption).  If the exemption ultimately did not sunset at the end of 2025, clients may wish they had this flexibility because they would (a) make the QTIP election and not use their exemption and then (b) arrange for the trustee of the QTIP Trust to distribute the QTIP Trust assets outright to the beneficiary spouse (pursuant to provisions in the QTIP Trust that would allow for such principal distributions to be made).  This approach would allow clients to set themselves up to use the exemption if it actually falls, but to take the gifted assets back if the exemption remains unchanged.

[13] The reciprocal trust doctrine originated in Lehman v. Commission of Internal Revenue, 109 F.2d 99 (C.A. 2d Cir.), where the court in that case relied on a quid pro quo test.  Grace was the first instance in which the doctrine was in front of the Supreme Court, and the Supreme Court rejected the quid pro quo test.  The Grace test is the one looked to by practitioners today.

[14] The term “parties” is intentional, since the reciprocal trust doctrine can be applied in situations where the settlors of various trusts are not spouses.

[15] Husband was treated as if he had created for himself the trust wife actually created for him.

[16] This assumes that the couple has the assets to accomplish this, which will not always be the case.

[17] In some cases, taxpayers wait to take the next step in a tax plan until the statute of limitations to audit the gift tax return filed to report a gift to a trust has run.  In the context of SLATs, however, since the reciprocal trust doctrine is generally applied to cause estate tax inclusion of SLAT assets in the estate of the first spouse to die, the swap must occur before death.  Hiding from the challenge by waiting for a gift tax statute of limitations to run doesn’t help in the context of SLAT planning.

[18] Of course, the goal would be for the SLAT to be as “big” as possible when the settlor dies, to avoid the most estate (and later generation-skipping) tax.  If all the income of the SLAT is required to be distributed currently, that SLAT would not be as “big” as desired to accomplish this end.  However, if the assets of the SLAT are held in an entity such as an LLC, until the LLC makes distributions to the SLAT, there is no “trust accounting income” that must be distributed.  If structured in this fashion, the SLATs arguably do not leave each spouse in the same economic position as they would have been if each had created the other SLAT for himself or herself.  But accumulating income in the LLC of the “all the income to spouse” SLAT still permits the maximum amount to pass transfer tax-free for future generations.

[19] Of course, distributions to charity would be unlikely from a SLAT that permitted it – as that would take assets that would otherwise pass to children without transfer tax away from the children and provide those assets to charity which could have received those assets directly from either spouse without the imposition of transfer tax.  However, naming charity as a permissible beneficiary of one of the SLATs does make one SLAT different from the other.  And if modest distributions are actually made to charity from that SLAT from time to time, it will buttress the argument that SLAT-1 and SLAT-2 leave the two spouses in different economic positions than if they had created trusts for themselves – helping avoid the application of the first prong of the Grace test.  If one SLAT is for spouse and issue, showing a history of making distributions for issue during the spouse’s lifetime would also provide a good fact to use in fighting the application of the reciprocal trust doctrine.

[20] However, see Bischoff v. Commissioner, 69 T.C. 32 (1977).

[21] The downside of SLAT-2 being a Springing SLAT is that if the couple needs to draw down on SLAT-2 before one of them has died, the assets of SLAT-2  would be unavailable.  If the clients really needed access to SLAT-2, they would have to borrow from SLAT-2, since SLAT-2 would only be for children until the donor spouse’s death.  To mitigate this risk, consider funding SLAT-1 (a traditional SLAT) and SLAT-2 (a Springing SLAT) each with a 50% interest in a primary residence or a vacation residence.  Since one spouse is the beneficiary of SLAT-1, that spouse can have the right to use the residence rent-free. Thus, both spouses can use the residence rent-free as long as the beneficiary spouse is alive.  If the beneficiary spouse of SLAT-1 dies, then SLAT-2 would “spring” and the surviving spouse would be a beneficiary of SLAT-2 – still having the right to use any residence held by SLAT-2 and that portion of the residence that was held by SLAT-1 which, on the death of the first spouse, is now retained in trust for the children. Note though that in the divorce context, a Springing SLAT that doesn’t “spring” on the death of the donor spouse would be undesirable where each spouse wants to be a current beneficiary of his or her SLAT.

[22] In Bischoff, husband and wife each created identical trusts for the benefit of grandchildren, naming the other as trustee. Each settlor (husband and wife) gave the other, as trustee, the right to alter, amend or terminate the trust (not in favor of the settlor), and that this amounted to a right to increase or diminish the beneficial interests of the respective named beneficiaries.  Because the trusts were interrelated and the power to change the beneficial interest would have caused inclusion if retained by the settlor, the Tax Court held that the reciprocal trust doctrine applied, which caused the trusts to be “uncrossed”.  As a result, husband and wife were deemed to have been the transferor of the trust created by the other and to have the retained the power (as trustee) to change the beneficial interests of the beneficiaries, which caused inclusion in their respective estates.

[23] Remember that the uncrossing of SLATs to cause inclusion using the reciprocal trust doctrine is based upon Internal Revenue Code Section 2036 – where a donor makes a transfer and retains an interest in the donee trust.  Here, spouses made transfers to trusts but because the trusts were for the benefit of their grandchildren, they didn’t retain an interest that caused estate tax inclusion.

[24] Though to create generational planning, the best approach would be to keep assets in trust rather than distribute them outright at ages.

[25] Note that if the beneficiary spouse exercises such a limited power of appointment, he or she may be making a gift.  If such a power is exercised in favor of charity, the spouse should get a gift tax charitable deduction.  While including a lifetime power of appointment may help the SLATs look different, the beneficiary spouse should consider whether or not there are adverse gift tax consequences if he or she actually exercises the power.

[26] Note that limiting investment discretion is generally inadvisable, especially in generational planning, but perhaps it could be made applicable solely during the life of the spouse.

[27] Note that in varying administrative provisions, practitioners and clients may want to consider whether or not an institutional trustee (if one is desired) will accept such provisions.

[28] For example, as mentioned earlier in this article, SLAT assets could be held in an LLC where the SLAT is the sole member.  Until there are distributions from the LLC to the SLAT, there is no trust accounting income to distribute pursuant to the mandatory distribution standard.  The effect is to allow accumulation in the SLAT even though it has a mandatory distribution provision.  And if the beneficiary spouse were in need of funds, the LLC could distribute cash to the SLAT that would then pay it out to the beneficiary spouse.

[29] Treas. Reg. Section 2514-1(b)(1)

[30] Treas. Reg. Section 25.2511-(c)(1) provides, in pertinent part, “The gift tax also applies to gifts indirectly made.  Thus, any transaction in which an interest in property is gratuitously passed or conferred upon another, regardless of the means or device employed, constitutes a gift tax.”

[31] Treas. Reg. Section 25.2511-(c)(1); Similarly, where a child, who is a current or remainder beneficiary of the SLAT, acts as a trustee, he or she would be making a gift if he or she exercises a discretionary power, which is not constrained by an ascertainable standard, to make distributions to the beneficiary spouse.

[32] Otherwise, if the beneficiary spouse acting as trustee could make distributions to himself or herself he or she would have a general power of appointment and the SLAT assets would be included in his or her estate.

[33] IRC 2041(b)(1)(A); Treas. Reg. 25.2511-1(g)(2) provides, in pertinent part, “If a trustee has a beneficial interest in trust property, a transfer of the property by the trustee is not a taxable transfer if it is made pursuant ot a fiduciary power the exercise or nonexercised of which is limited by a reasonably fixed or ascertainable standard which is set forth in the trust instrument.”

[34] See, e.g., Gokey v. Commissioner, 735 F.2d 1367 (7th Cir. 1984); Richards v. Commissioner, T.C. Memo 1965-263

[35] Sullivan at 1335

[36] Note that the courts and the IRS have rejected the argument that the application of 2036(a)(1) should rest on whether or not distributions are actually made.  See, e.g., Pardee v. Commissioner, 49, T.C. 140 (1967); Rev. Rul. 2004-64.

[37] See Sullivan; McTighe.

[38] See discussion above regarding Section 2041, Section 2514 and Section 2511 of the Internal Revenue Code.

[39] Note that an independent trustee may charge fees to serve as trustee, which will reduce the amount that stays in trust.

[40] If the surviving spouse is given the power to remove and replace the trustees of the terminated SLAT-1 which after the donor spouse dies is held for the children, the surviving spouse has the ability to put in place a trustee who will loan funds to the surviving spouse if the acting trustee refuses to do so.

[41] Trusts created in states with asset protection statutes, such as Delaware or Alaska, may provide the beneficiary spouse, at the beneficiary spouse’s death, with the power to appoint the assets, in trust, for the donor spouse.

[42] In that instance, the SLAT husband created for wife effectively serves as a life insurance trust to avoid estate tax on the proceeds when husband dies, and again when wife dies and the assets pass to trusts for children (and more distant issue if GST exemption has been allocated to the SLAT making it exempt from the GST).

[43] Wife would not be wanting to receive a SLAT distribution and spend it on herself and her (ex) husband!

[44] Of course, in this circumstance, there are less assets available to both spouses upon distribution of the marital estate.

[45] If a husband and wife have SLATs with this presumption of death on divorce and the husband and wife are contemplating divorce, the SLATs should be decanted pursuant to the SLAT terms or pursuant to state statute (where applicable) in order to remove that presumption.

[46] Note that this requires cooperation of the donor spouse to appoint a Trust Protector to exercise this power.  The donor spouse may or may not be incentivized to do this, so there is a risk with a Hidden SLAT that, in a divorce, one spouse may be disadvantaged.

[47] Sections 677(a)(1) and 677(a)(2) of the Internal Revenue Code provide that where one spouse creates a trust for the other and that beneficiary spouse may receive distributions of income and/or the assets of the trust can be held for future distribution to the grantor’s spouse without the approval or consent of any adverse party, the trust is a grantor trust.  This means that all items of income, deduction and credit of the SLAT are reported on the grantor’s income tax returns.  There is a discussion among practitioners regarding the ability to create a “SLANT” (a Spousal Lifetime Access Non-Grantor Trust) which focuses on the use of adverse parties to “cut” the grantor string and allow the SLANT to be taxed as a non-grantor trust.  The IRS has not issued any guidance or authority on this technique and it is not without risk.  An in-depth review of SLANTs is beyond the scope of this article.

[48] There are many grantor trusts that can be “flipped” to non-grantor trust status by releasing certain powers (e.g., the power to swap assets or the power to borrow without interest).  It is not possible to turn off grantor trust status in this fashion for a SLAT so long as the beneficiary spouse remain a beneficiary of a SLAT.

[49] Under Revenue Ruling 2004-64, such provision by itself would not be deemed a retained interest that would subject the trust to estate tax on the donor spouse’s death under IRC Section 2036 unless there are other issues causing inclusion, such as a provision under the applicable state law that gives the donor spouse’s creditors access to the trust’s funds if the reimbursement provision is added to the trust.

[50] If there is a right for an independent trustee to reimburse the grantor for income tax paid on SLAT income, that would solve the problem – unless the beneficiary spouse controls the appointment of the independent trustee who would make that determination.  There could, instead, be an offset in the amount of spousal support for the income tax that the donor spouse paid on the income earned by the SLAT administered for his or her ex-spouse’s benefit.

[51] This assumes the parties are friendly enough in the context of divorce to come to this agreement.  In those circumstances, they might choose an accountant they both trust to do the calculations and let them know who must true up whom at the end of the year – keeping their non-SLAT income private from each other.  This is another provision that could be put into a post-nuptial agreement as part of the SLAT process, in case the couple is not friendly enough at the time of divorce to come to this agreement.

[52] Thought may be given in this circumstance as to whether practitioners recommend spouses retain separate counsel for purposes of reallocation or transmutation.

[53] In reality, not all clients who seek to use exemption will have sufficient assets to view a SLAT in this way.  In such cases, practitioners may caution the clients about the risk of the plan being challenged (for example, there may be a greater risk of a challenge that there was an implied agreement with the trustees).  In these instances, it may be beneficial to use an independent institutional trustee with whom such an assertion of an implied agreement may be more difficult.

[54] For those on the fence about making such a large gift now, they could consider funding the SLAT with a small seed gift and then loaning a substantial sum to the trust, with the idea that the loan could be forgiven on December 31, 2025 if it looks like the sunset in the exemption really will occur.  Alternatively, if it looks like the current exemption levels will be extended, the client could simply have the trustee of the SLAT repay the loan, thereby returning the assets to the lender and leaving the client in the same position as he or she was in before the SLAT planning was undertaken.

[55] When making a gift of an illiquid and hard to value asset, clients could consider using a defined-value “Wandry” gift to reduce the risk of a gift tax liability if the IRS challenges the valuation.

[56] It is important that in the face of the potential sunset of both the estate tax exemption and the GST tax exemption that clients allocate GST tax exemption to their SLATs.