The 2017 tax reform legislation dramatically expanded the transfer tax exemption beginning in 2018, making it much more likely that even super wealthy clients may no longer be subject to the federal estate tax.
On the other hand, the legislation also created a brand new “fiscal cliff” situation, meaning that the current exemption is scheduled to expire (or “sunset”) after 2025—at which point, the exemption would revert back to its 2017 level.
Clients who anticipate leaving an estate valued above the approximately $5.6 million level may hesitate to engage in planning strategies that would restrict their access to such substantial fortunes, but trust structures exist to both allow a certain degree of access and lock in the current exemption—and because the sunset provision has placed an expiration date on their viability, the clock is ticking.
The 2017 tax reform legislation roughly doubled the transfer tax exemption to $11.18 million per individual, or $22.36 million per couple, for 2018-2025. Absent Congressional action to extend the expansion, the per-person exemption will revert to its $5.6 million level beginning in 2026. Because the transfer tax exemption exempts both transfers at death and transfers made during life from estate and gift taxes, the expansion has created an opportunity for wealthy clients to shield an even greater portion of their estates from eventual taxation.
A spousal lifetime access trust (SLAT) is one type of irrevocable trust that can potentially allow a client to remove assets from his or her estate while also maintaining access to those assets during life. To fund a SLAT, a married client transfers assets into the irrevocable trust for the benefit of his or her spouse. An independent trustee is appointed to oversee the trust (adult children may serve as trustee so long as a concrete, ascertainable standard exists for trust distributions).
The gift to the irrevocable trust removes the assets from the client’s estate, but allows his or her spouse to access the trust assets if necessary. The strategy allows the client to retain a degree of control over the assets, and also puts the assets out of the reach of his or her creditors.
In some cases, it may be advantageous to partially fund the trust with a life insurance policy to pay substantial benefits at the client’s death. The policy premiums could be funded with the income earned on other assets that are placed in the trust. This can provide an option for tax-free distributions if a cash value policy is used.
One obvious downside to the SLAT strategy is the risk of divorce. If the client divorced his or her spouse, that spouse would remain beneficiary of the SLAT and the client would no longer have control over those assets because the trust is irrevocable.
Clients who created a SLAT in 2012, when the last “fiscal cliff” situation motivated action steps to take advantage of the potentially expiring $5 million exemption, should consider the potential application of the reciprocal trust doctrine. This rule was developed to prevent two individuals from creating identical trusts that would each benefit the other, while at the same time removing the assets from the individuals’ respective estates.
As a result, it is important to ensure that the two SLATs are not identical. This can be accomplished by providing different trustees, different rights to access the trust assets (e.g., one trust could allow access to principal, while the other only permits access to income) or adding children as beneficiaries to one of the trusts. The length of time that has elapsed between a SLAT created in 2012 and a SLAT created now also substantially reduces the risk that the IRS will determine that the reciprocal trust doctrine should apply.
The uncertainty created by the 2017 tax reform legislation’s impact on the potential application of the estate tax has created a new need for the very wealthy to plan to minimize their potential taxable estates. A SLAT is one technique that can provide a “best of both worlds” solution for clients who anticipate needing access to the assets placed in trust.
- Check out previous coverage of post-reform tax planning in Advisor’s Journal.
- See in-depth analysis of estate planning strategies in Advisor’s Main Library.
- Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.