The proposed federal tax legislation reduces our gift/estate/generation skipping transfer tax exemptions from the present $11.7 million to approximately $6 million. Even if the legislation is not enacted, the current exemptions sunset on December 31, 2025, resulting in a similar reduction.
The Wall Street Journal, New York Times, Forbes, Money, and a variety of other publications post articles about Spousal Lifetime Access Trusts as a means for married couples to consume your exemptions before they’re reduced. Consequently, individuals tend to believe SLATs are form documents that are all similar. Lawyers who aren’t well versed in the tax law may in fact, create such forms.
Here I’ll explain SLATs in greater detail, so you’ll be a well-informed client. A SLAT is a technique where spouses each place investment assets into an irrevocable trust for the other. It’s important to note that SLATs are irrevocable, which means just that. Once you have signed and funded the trust with assets, it’s difficult to undo the transaction without adverse consequence.
The main idea behind this strategy is that you wish to consume your lifetime gift tax exemptions before proposed legislation is enacted. As you know, your gift and estate tax exemptions work together. What you use during lifetime you can’t use at death. You also have Generation Skipping Transfer Tax (GSTT) exemptions that can be used before they’re reduced.
When consuming your GSTT exemption you’re not necessarily “skipping” your children. Instead, you’re placing assets in a trust for your children, that can continue on for your grandchildren without being included in your children’s estate for federal estate tax purposes. You’re “skipping” them for tax purposes, which is a good thing.
Congress doesn’t want you skipping your children. That’s why SLATs that terminate at your children’s level is not good planning. (Same logic for your revocable trust planning, but that’s for another column.) What’s important to know is that the GSTT is a “penalty tax” in that it is imposed on transfers that benefit two generations or more below yours above your applicable exemption. Once your GSTT exemption is consumed, any additional transfers are assessed a tax at the highest marginal estate tax rate in addition to the estate tax.
Consequently, your attorney needs to review any prior federal gift tax return Form 709s that you have filed to determine how much gift/estate tax exemption you have remaining, as well as how much GSTT exemption you have. Those two numbers may not be the same, which consequently affects the SLAT implementation.
With a SLAT, generally, the income earned on the investments transferred to the trust may be paid to your spouse. In other words, Husband’s SLAT for Wife could pay Wife income while vice versa. Attorneys and their clients must be mindful of the IRS’ “Reciprocal Trust Doctrine.” If the two SLATs look similar, were created at the same time, and funded with similar assets this doctrine invalidates the transfer.
As I’ve stated previously, while many believe a SLAT defines one specific type of trust, there are many options when creating one. Consequently, it’s common for one individual’s SLAT to have very different provisions than another’s. Moreover, everyone has different assets that they’ll use to transfer into their SLAT. Unrealized gain, dividends, interest, growth, and other variables play into the success of the strategy.
Remember that gift transfers during life do not receive a step up in tax cost basis when the transferor dies. Contrast this with post-death transfers, which do receive a step-up. As an example, if I own 100 Shares of ABC Company, and my tax cost basis is $50,000 but their current fair market value is $100,000, if I put them in a SLAT during my lifetime for my wife and then it is distributed to my children, they take the same $50,000 basis that I have. If they were to sell the shares for $100,000 then they would recognize a $50,000 capital gain. If, on the other hand, I die holding those same shares, and bequeath them in trust to my wife and then children, they receive a step-up to $100,000. Consequently, if my wife as trustee sells the shares after my death for $100,000, then the trust doesn’t recognize capital gain.
This example illustrates why it’s important for you to consider the tax cost basis relative to fair market value of the assets you intend to use to fund the SLATs. Growth should also be considered, and whether assets are appropriate for long-term holding.
The amounts that you transfer into your SLATs will largely be dependent upon several factors, including your comfort level and risk tolerances.
Income tax planning for your children can also be incorporated into SLATs. Hopefully, this income tax planning is also present for your children in your revocable living trust shares for them, and any other trusts you’ve created. Strategies exist that enable your children to determine whether they wish to be the taxpayer for income tax purposes or whether they want their trust share to be the taxpayer.
Good planning also incorporates “sprinkle” provisions which enable your children to distribute income to their children (and one day grandchildren) which enables them to get money where it’s needed for education, home purchases, business startups, health care costs and the like. The income tax liability follows the distribution, so if your grandchildren are in a lower income tax bracket, then the family save taxes. Further, when making these distributions of income, it is not a gift, preserving your children’s ability to use their federal gift/estate tax exemptions on their own assets.
Finally, it’s important that your estate plan contain provisions enabling for the merger of like-kind trusts shares, which in turn minimizes your children and grandchildren’s tax return reporting requirements.
So, as you can see, there’s more to SLATs than standard boilerplate. If you have a larger estate that might be subject to tax, it’s important to consider this technique before your exemptions are reduced.
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