The number of trusts that can anchor an estate plan reflect the nearly infinite variety of objectives and circumstances that motivate a person or couple to initiate their planning process.
However, many types of trusts involve certain trade-offs, due to rules that our legal system inherited from English common law. For instance, unless you live in one of the 17 states that allow for domestic asset protection trusts, the general prohibition against “self-settled spendthrift trusts” makes it difficult to create a trust, move your own assets into it, and continue to benefit from those assets without also leaving them open to the claims of your creditors.
Benefits of a SLAT. Married couples can get around that issue with a “spousal lifetime access trust” (SLAT), which provides asset protection during a person’s life, maintains indirect beneficial access to the assets through one’s spouse, and avoids estate tax liability by moving assets out of one’s estate permanently.
As we have discussed in previous articles, if Congress does not act, after 2025 the estate tax exemption will drop from $13.99 million per person to just $6.2 million (i.e., $5 million adjusted for inflation). As a consequence, your seemingly modest estate, which up to this point has not warranted estate tax planning, could become subject to taxation after your death. The looming possibility of estate tax liability in the future, where none exists now, makes discussions of estate tax strategies a timely exercise.
Those strategies might include a SLAT, an irrevocable trust into which each spouse gifts their assets for the benefit of the other. Doing so removes those assets from the donor spouse’s taxable estate but preserves indirect access to those assets via the beneficiary spouse.
Here’s how it works.
SLATs are typically created in pairs, although, for reasons explained below, not identically and not at exactly the same time.
In Arizona and the eight other community property states, creating a SLAT is a little more complicated than in a separate property state. To address issues of community property, the process starts with the creation of a partition agreement between the spouses. A partition agreement essentially divides, or “partitions,” the couple’s community property so that 50% of it is recharacterized as sole and separate property owned by each spouse.
After that step is completed, the husband, for example, will create SLAT #1 for his wife’s benefit. She will be the primary beneficiary and the trustee. After her SLAT is set up, he will donate to it his sole and separate property, which, due to the partition agreement, now includes his half of the former community property.
Similarly, and at approximately (but not exactly) the same time, the wife will create SLAT #2 for her husband. He will be the primary beneficiary and the trustee, and she will donate into SLAT #2 her sole and separate property.
The need for differences in time and terms stems from what is known as the “reciprocal trust doctrine.” A SLAT must be drafted around that doctrine; if the pair of trusts mirror each other too closely in time, and if their provisions are too similar, they become vulnerable to challenges by the Internal Revenue Service. Where there was not sufficient separation of the two SLATs, the U.S. Tax Court has allowed the IRS to disregard them and, instead, treat that as one large trust that eviscerates many of the benefits that the couple was trying to achieve.
To get around the reciprocal trust doctrine, the spouses might sign their trusts a month or so apart, and the attorney who drafts the trusts should include enough differences – e.g., regarding beneficiaries and powers of the trustee – that the two trusts are not mirror images of each other.
Potential Drawbacks. The reliance of a SLAT on one’s spouse for maintaining indirect beneficial access to the assets creates for the grantor potential problems in two common situations: divorce and premature death. The former can be drafted around by making the primary beneficiary “my current spouse,” which allows the grantor to regain beneficial access by remarrying in the future.
The latter is a much more serious problem in most states without domestic asset protection trust (DAPT) laws. If your spouse dies unexpectedly, the secondary beneficiaries (usually your descendants) inherit immediately, and beneficial access to those assets is lost to the grantor permanently.
However, despite not yet having a DAPT law, Arizona does have an unusual statutory provision, found in A.R.S. §14-10505(E), that addresses this issue gracefully: When the first spouse dies, the surviving spouse is allowed to step into the deceased spouse’s place as the primary beneficiary of the SLAT, which ensures that the couple will not lose access to assets prematurely.
Conclusion. For many couples, a SLAT can provide asset protection and avoid estate taxes while preserving the ability of both spouses to enjoy the use of their assets.
While the benefits of this strategy can be significant, a SLAT is not for everyone, and it should be pursued only after discussing the pros and cons with an experienced estate planning attorney.