Trusts 101 for physicians part 6: SLATs

What is a Spousal Lifetime Access Trust or SLAT?

A SLAT is an irrevocable trust established by one spouse for the benefit of another and typically, additional heirs like children and grandchildren.

What is a SLAT used for?

A SLAT can have several legitimate uses, but the two most common ones are estate tax avoidance and asset protection.

How does a SLAT reduce estate taxes?

A SLAT can help legally avoid estate taxes on contributed by “locking-in” the Grantor’s current individual estate tax exemption (currently $12.06 milllion per person) to transfer assets to the trust and outside their future taxable estate and the taxable estate of the spouse and other beneficiaries. By doing so, any appreciation the transferred assets enjoy is also outside the taxable estate of both the Grantor and the Beneficiary, as it is now trust property and outside their ownership and control, but not outside their use and enjoyment.

How can a SLAT provide asset protection?

A properly drafted SLAT can provide asset protection for the assets transferred to it because the assets have been transferred to the ownership of an irrevocable trust that is legally distinct from the personal and professional liability of the Grantor and Beneficiaries. Those concerned with creditor protection should ideally use a third-party trustee that is neither a Grantor nor a Beneficiary, or at the very least carefully limit the distribution authority of a beneficiary and consider the use of co-trustees. A variety of controls and limitations on the Trustee’s distribution of trust assets can be included in the SLAT to provide additional protection, as assets distributed out of the trust, directly to a Beneficiary are no longer protected.

How do SLAT assets get used?

The trustee of the trust can make distributions of the trust’s assets and income to the Beneficiary spouse for a variety of needs ranging from basic health and maintenance to income distributions required to maintain a specific lifestyle or income level. In the past, higher net worth individuals were often advised to consider limiting contributions so that they retained enough wealth outside the trust for their expected living expenses to make trust distributions unnecessary, thus ensuring that the maximum amount possible passed to the next generation. While that strategy remains valid, I’ve seen an increasing number of people at a wider range of net worth levels taking of advantage of this strategy because of the predictably this provides their heirs against taxes and creditors as outlined above.

Who pays the taxes on a SLAT?

In most cases the SLAT is a Grantor Trust, which means that any tax due on the income of the trust is paid by the Grantor during their lifetime, not the trust itself or the beneficiaries. If carefully drafted, calculated and distributed as an explicitly discretionary distribution by the trustee, a SLAT may even have a clause that allows the Grantor to be reimbursed for income tax expenses by the trust.

What assets can you put in a SLAT?

A SLAT can hold a wide variety of assets, but the assets do need to be the separate property assets of the grantor. A SLAT is especially favored for assets with a low basis and high appreciation and may include cash, stocks, bonds, real estate, interests in businesses, life insurance policies and high value personal property collections, like art.

Downsides of using a SLAT

I’m frankly not even sure these are actual “negatives” but rather the detail and compliance required to predictably enjoy the benefit of a SLAT. Here’s some of the “fine print” to be aware of:

• Requires careful professional drafting and strict compliance on tax reporting, distributions and other details to avoid being comprised to avoid being compromised on tax benefits, creditor protection or both.
• Creates risk of loss of “second-hand” benefit and enjoyment of assets in the event of death of Beneficiary spouse or a divorce.
• Assets are less agile and liquid in how they can be deployed, must be funded carefully with assets this fact pattern actually works for.
• Requires use of 3rd party trustee
• Requires tax return at the death of Grantor or immediately, if not taxed as a grantor trust
• Requires filing of a gift tax return when assets are transferred into the SLAT