SLAT is tax ‘acronym du jour’ for the married and wealthy: What you need to know

Being happily married, healthy and wealthy is one of life’s great trifectas. There’s a tax perk that can make it even sweeter.

Among financial advisors with those clients, a wealth-planning strategy is surging in popularity as lawmakers debate tax increases to fund the Biden administration’s social spending and climate agendas. Known as a spousal lifetime access trust, or SLAT, the maneuver has a major benefit for high net worth couples: The ability to whisk assets out of their taxable estates while still benefiting from them during retirement.

“It’s become the planning acronym du jour,” said Martin Shenkman, an estate planning lawyer based in Fort Lee, New Jersey.

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A SLAT isn’t a simple add-water-and-mix move. It’s easy to get the requirements wrong, void your arrangement and end up owing the IRS millions of dollars. But when done right, some estate planners call it the perfect tax break for the perfect couple with the perfect lifestyle.

“It’s ‘have your cake and eat it, too’,” said Kristin Shirahama, a trusts and estates lawyer focused on tax at law firm Bowditch & Dewey in Framingham, Massachusetts.

The trusts are a form of so-called grantor trusts, in which a donor, or grantor, transfers assets but retains a degree of control. Grantor trusts appeared last fall to be on the chopping block when the House of Representatives released its first version of tax-and-spending legislation to finance President Joe Biden’s Build Back Better plan.

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Their proposed curb is no longer on the table, at least for now. The Senate Finance Committee, now working on its own changes to the Build Back Better bill passed by the House last month, didn’t mention any proposed restrictions on Dec. 11 when it released 1,180 pages of “updated text” to the bill. (That document also didn’t include a proposal for a billionaire’s tax or any mention of relaxing the $10,000 SALT cap on deducting state and local taxes, which includes property levies.)

How it works
A spouse sets up a SLAT for the benefit of her partner by transferring assets held in her name only. Most married couples own property and investment accounts jointly, so those need to be placed into separate accounts with separate ownership before being transferred (a lengthy process in community property states like California). The idea is to transfer assets, including life insurance, into the trust so that your estate dips below the historically high federal exemption levels, now $11.7 million and $23.4 million, above which the 40% gift and estate tax kicks in. The levels, doubled after the 2017 tax-code overhaul, will drop to half as much, plus a little more for inflation, come 2026.

The donor pays tax on the trust’s taxable income when filing her personal return. Children or grandchildren can be named as later beneficiaries. A SLAT has to have a trustee. That person can’t be the donor and can be the beneficiary only if their power to move money out of the trust is limited.

Under current law, individuals who inherit assets generally don’t owe tax on the gains made since the original owner acquired them. SLATs don’t get that benefit when the donor dies, which means that a beneficiary can owe big capital gains taxes when selling any of its holdings.

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As usual in the tax world, there’s a way around that hit: The donor can swap stock or property in the trust whose tax bill would be high for separate assets that haven’t appreciated as much. The original “low basis” assets formerly in the trust would then become part of the donor’s estate, and heirs wouldn’t owe gains on their appreciation while they were in the trust.

Complexity aside, “it’s definitely been something a lot of our clients have explored and executed,” said Dave Jones, a senior vice president and director of estate strategy at Bailard, a registered investment advisory firm in Foster City, California.

'Not a personal checking account'
Now comes the fun part. The donor spouse has effectively given the beneficiary spouse the assets. But the spouse who’s the beneficiary can request withdrawals from the SLAT to fund basic lifestyle needs and pursuits, like vacations, mortgages or home remodeling. Because both spouses typically live in the same home and vacation together — our perfect couple — the donor spouse benefits as well.

“It’s an irrevocable gift, but if you ultimately need to tap into those funds, you can do so through your spouse,” said Bradley Crockett, the national director of advanced financial planning at M&T Bank’s Wilmington Trust. Still, he added, “it’s not a personal checking account.”

That’s because the trusts are typically set up so that distributions are under what the IRS calls health, education, lifestyle maintenance or support guidelines. So-called HEMS can get squishy come tax return time.

Say a married couple has taken an annual, two-week vacation to the Riviera for 40 years. The wife dies, and the husband who now controls the SLAT decides to tap into it to cruise the Mediterranean for three months on a luxury yacht. That’s beyond his normal standard of living, so it wouldn’t be allowed under IRS rules.

“I can’t tell you how many times I’ve seen that,” Shenkman said, citing the examples of a widower who “needed a quarter-million dollar sports car to get over the grief of losing his wife” and a widow who quickly bought an expensive house after acquiring a new boyfriend.

The IRS and children who are heirs can glom on to such potential abuses when the SLAT donor dies, which causes the trust’s inner working and use to be detailed in her estate’s federal return. IRS employees actually read the trust document’s terms to see if a standard has been violated, Shenkman said.

Divorce and death can ruin everything
If you get divorced, the donor spouse loses access to the trust. Because a transfer of assets into a SLAT is irrevocable, that means your ex continues post-marriage as the beneficiary, a likely bitter pill to swallow. A donor spouse whose partner dies can no longer access the trust.

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While there are fancy ways a SLAT can be structured to allow money to be returned when a spouse dies and allow a new spouse to become the beneficiary (the so-called “floating spouse” provision), they’re complicated. In general, you have to stay married and alive. “Some of these pitfalls are not attractive,” Shirahama said.

Things get turbocharged when each spouse creates a SLAT for the benefit of the other.

But even assuming our happy and healthy married couple stay that way, there are pitfalls to that twofer.

Under what’s known as the reciprocal trust doctrine, rules hammered out over the years by the U.S. Supreme Court and U.S. Tax Court ban what the IRS deems to be abusive arrangements in which two identical trusts are used by the same married couple to avoid estate taxes while remaining in the same economic position as beneficiaries of the trusts.

“There are some big no-nos,” Shirahama said, citing trusts that are created and funded at the same time and with the same amounts and terms. Still, she added, “it’s not too hard to make them look different.”

Jones of Bailard said that SLATs were “ideal” for couples with a net worth under $50 million. “They can use up their full exclusion and still have access to the money,” he said — valuable for, say, a doctors’ practice that might face medical liability issues or private businesses from which owners don’t take a lot of income. Or for clients “with lifestyles with high burn rates,” he said. “It also comes down to feelings about money and how much they feel they need to have.”

--To receive free CE credit for reading this piece, please see CE Quiz: January 2022. You can access previous months' CE quizzes here: Financial Planning CE Quiz.