SLATs Provide Tax Savings Now that Are Not Guaranteed in the Future
August 3, 2020
- Spousal Lifetime Access Trusts (SLATs) are an important tool for married couples seeking tax savings now that may not be available in the future.
- Depending on the result of the November election, a potential reduction in the gift/estate tax exemption could drastically change federal taxes that are owed.
- Individuals and families should speak with their advisors as soon as possible to weigh the pros and cons of an estate planning strategy that utilizes SLATs.
If there is a year in recent history that could be characterized as uncertain, 2020 is that year. The COVID-19 pandemic has wreaked havoc on the world economy and the lasting impact of the government-ordered lockdowns in response is largely an open question. Not to mention, 2020 is an election year and who will ultimately win in November is anyone’s guess. Despite the fog of uncertainty, there are estate planning tools available to those who proactively seek tax-saving opportunities that may be unavailable in the future. This article discusses one such tool: a Spousal Lifetime Access Trust (“SLAT”).
In general, when there is a change from a Republican to a Democratic administration, estate and gift tax exemptions become common political footballs. The estate and gift tax exemptions are currently $11.58 million and this amount is subject to yearly inflationary adjustments. These thresholds were established by the “Tax Cuts and Jobs Act,” which was signed into law under the current administration in 2017. This means an individual can currently make gifts of property or cash to others valued at or up to $11.58 million over his or her lifetime without paying federal gift taxes. For purposes of federal estate taxes, this means an individual may currently have an estate of up to $11.58 million without paying federal estate taxes at death. It should be noted that if the exemption amount is used with gifts, the estate tax exemption is reduced dollar for dollar and only the balance, if any, of the exemption is available to reduce estate taxes.
Estate and gift tax exemptions are subject to attack on two fronts: (1) they are slated to sunset on January 1, 2026, meaning the exemptions will return to around $5 million, adjusted for inflation; or (2) in the event the Democrats take control of the White House and Senate, they could reduce the exemptions more drastically and sooner than 2026. For instance, a recent proposal by Senator Bernie Sanders advocated for a reduction of the exemption to $3.5 million. Other proposals are even more extreme, advocating for a reduction of the exemption amount to just $1 million. Despite these potential drastic changes, establishing a SLAT now provides a defense from both potential attacks while still allowing access to assets and the added benefit of tax-free appreciation.
What is a SLAT?
A SLAT is a type of trust that allows one spouse to gift assets to the trust for the benefit of the other spouse and/or their dependents. This transfer to the SLAT removes the gifted assets from the estates of both spouses and, depending on how the trust is structured, from the estates of the dependents. Further, SLATs are typically “grantor trusts,” meaning that the transferor-spouse is responsible for paying income taxes associated with the SLAT. This provides the transferor-spouse the option to pay the income taxes associated with the SLAT’s investments without the government treating the payments as an additional gift.
How Can a SLAT Help Me?
In short, a SLAT allows for the avoidance of probate, avoidance of estate taxes, the transfer of tax-free appreciation, and asset protection while still allowing some access to the assets in the trust. Because any assets transferred to the SLAT are removed from the transferor-spouse’s estate, the spouse’s estate, and possibly the estates of their children, the assets will not be subject to probate and will not trigger estate taxes upon the death of either spouse or upon the death of the children, even if the assets have appreciated in value. Any assets transferred to the SLAT are well protected from claims of creditors of the spouses and other SLAT beneficiaries. In addition to all of these benefits, the transferor-spouse does not lose all access to the assets because he or she can still indirectly benefit from the use of trust assets through the other spouse.
Use it or Lose it: Tax Savings Now
SLATs are an important tool for married couples seeking tax savings now that may not be available in the future. The following example helps to illustrate this point.
Jack and Jill are married. Jack has $7 million in assets that he wishes to use to benefit Jill and their children. As previously discussed, the estate tax exemption is currently $11.58 million. In November, the Democrats win the White House and control of both houses of Congress. Accordingly, they plan to reduce the estate tax exemption to $1 million, effective the following year. Further, the estate tax exemption remains $1 million at Jack and Jill’s death and current estate tax rates remain the same.
Because of the pending change to the exemption amounts, Jack establishes a SLAT for the benefit of Jill and transfers $7 million in assets to the SLAT before the change to the exemption goes into effect.
Jack and Jill both die 15 years later and the assets in the SLAT increase in value by an average of 8% per year since the date of transfer and are now worth $22,205,183.80. All the while, Jack (indirectly), Jill (as a beneficiary of the SLAT), and their children were still able to have access to the assets and benefit from them and their tax-free growth.
Cost of Waiting
The primary savings resulting from Jack establishing the SLAT are the estate taxes that may be due upon the death of the last to die of Jack and Jill (conveniently, they die at the same time in our example). Assuming the estate tax exemption would be $1 million at the deaths of Jack and Jill, if they would have died with these assets in their estates, then the estate of the last to die would face a tax bill of $8,082,073.52 relating to just the $22,205,183.80 of appreciated assets. (Other assets would also be subject to taxation). However, because the assets were in the SLAT, no estate taxes would be due on these assets. Therefore, in Jack and Jill’s case, the cost of waiting is approximately $8,027,873.52. Even if the $7 million of assets had not appreciated in value, the tax savings would be approximately $2.4 million.
The primary benefits of acting now to establish a SLAT are that the current exemption amount can be used before it might be substantially reduced by law or by an earlier act of Congress, and all growth within the SLAT is not subject to estate taxes. The net result of using the exemptions available now is the potential of a massive tax savings resulting from the exclusion of the transferred assets, plus any appreciation from the estates of the transferor-spouse and his or her family and the comfort of knowing that the assets will be protected from claims of creditors. All the while, the transferor-spouse (indirectly), his or her spouse, and their children, will still be able to enjoy the benefits of the assets as they appreciate. The amount of the tax savings is in direct correlation to the amount transferred to the SLAT, the appreciation in the value of the assets transferred, and the reduction to the transfer tax exemption. In fact, with proper planning, both spouses could establish a SLAT for each other thereby potentially doubling the tax savings.
When Should I Start This Process?
You should start speaking with your advisors now as the fall elections approach. Although there are many benefits to utilizing a SLAT, the best option for you will depend on your specific situation. Certainly, all the pros and cons of this planning should be discussed, and the sooner you begin the process, the higher the likelihood that you will make the right decision. In light of current economic and political conditions, the planning may work even better than normal if the assets transferred to a SLAT are currently down in value. Although we cannot predict the future of the estate and gift tax exemptions, one thing is certain: uncertainty. Planning now with a SLAT can help you take advantage of current exemptions while hedging against future reductions.