Spousal Lifetime Access Trust (SLAT) in New York

A Spousal Lifetime Access Trust (SLAT) is an increasingly popular estate planning tool among high net-worth couples whose assets exceed state and federal estate tax exemption thresholds. In this type of irrevocable trust, one spouse, known as the grantor-spouse, permanently transfers assets into the SLAT for the benefit of the other spouse and potentially other beneficiaries, such as their children. By designating the other spouse as a beneficiary, the grantor-spouse can effectively remove the transferred assets from their taxable estate while still indirectly benefiting from distributions made to their spouse. The beneficiary-spouse can use these distributions to cover joint expenses, including household and living costs and other lifestyle expenditures that benefit both spouses. To ensure the grantor-spouse's interests are protected in the event of divorce, it is crucial to work with a knowledgeable estate planning attorney like us when creating a SLAT.

How SLATs Work

A Spousal Lifetime Access Trust (SLAT) is an irrevocable trust that, once created, cannot generally be modified or terminated. The trust document outlines the beneficiary-spouse's right to request distributions, detailing the timing, quantity, and circumstances under which these distributions may occur. Although the grantor-spouse cannot directly access the funds, they can indirectly benefit from the distributions made to the beneficiary-spouse, as the trust can cover the beneficiary-spouse's living expenses and other lifestyle costs, which may include expenses shared with the grantor-spouse. Beyond the primary beneficiary-spouse, the SLAT can also designate secondary beneficiaries, such as the couple's children or grandchildren, who may receive distributions based on the trustee's discretion or following the beneficiary-spouse's death.

The irrevocable nature of a SLAT ensures that assets transferred into the trust are not only removed from the grantor's taxable estate but also shielded from the grantor-spouse's and beneficiary-spouses's creditors. SLATs are particularly well-suited for high-appreciating assets that are considered separate property, as both the current value and future appreciation of the transferred assets are excluded from the grantor's estate. For instance, if a $3M house is transferred to a SLAT now and appreciates to $6M by the time of the grantor's death, the entire $6M is effectively removed from the grantor's taxable estate. Had the property remained in the estate, it could have exposed the grantor to New York estate tax upon their death. Thus, by utilizing a SLAT, the grantor can achieve substantial estate tax savings.

Prohibition Against Reciprocal Trusts

Married couples often establish separate SLATs for each other, with each spouse serving as the grantor for one trust and the beneficiary for the other. This reciprocal arrangement allows high net-worth couples to remove assets from their respective taxable estates while still providing access to the trust funds for each other's benefit. For example, Spouse A can create a SLAT for the benefit of Spouse B, while Spouse B simultaneously creates a SLAT for the benefit of Spouse A. By establishing separate trusts, the couple can maximize the amount of assets removed from their combined taxable estates.

When establishing similar SLATs, it is crucial to ensure that the trusts are not considered "reciprocal" under the reciprocal trust doctrine. The reciprocal trust doctrine, established by the Supreme Court in United States v. Grace (1969), states that if two trusts have substantially identical terms and are interrelated, they may be "uncrossed," and the assets will be included in the grantors' taxable estates.

To avoid triggering the reciprocal trust doctrine, the SLATs created by each spouse should have distinct terms, beneficiaries, trustees, and provisions. Examples of differences that can help avoid the reciprocal trust doctrine include varying the amount of assets transferred to each SLAT, appointing different trustees for each trust, including different beneficiaries or distribution terms for each trust, and establishing the trusts at different times or in different states. We can guide couples in structuring their SLATs to minimize the risk of the reciprocal trust doctrine being applied.

SLATs, Coping with Changes, and Divorce

Decanting provisions can be incorporated into a New York SLAT to allow the trustee to transfer the trust assets to a new trust with more favorable terms, without the need for court approval or the consent of the beneficiaries. This process, known as decanting, can provide flexibility to address changes in circumstances or tax laws that may impact the effectiveness of the original SLAT.

Appointing a trust protector is another effective method for indirectly modifying a SLAT in New York. A trust protector, an independent third party, is granted specific powers to modify or amend the trust under certain circumstances. These powers may encompass the authority to remove and replace trustees, alter the trust's situs or governing law, or adapt distribution provisions in response to changes in tax laws or beneficiaries' needs. Including a trust protector provision in the SLAT enables the grantor to maintain the trust's flexibility and adaptability to future changes without compromising its irrevocable nature. Should tax laws change in a manner that adversely affects the SLAT's effectiveness, the trust protector may have the ability to amend the trust terms, minimizing negative consequences and preserving the grantor's original intent. However, to avoid undermining the SLAT's irrevocable nature and potential estate tax inclusion, the powers granted to a trust protector must be carefully defined and limited.

Lastly, given the possibility of divorce, it is crucial for an estate planning lawyer to include provisions in the SLAT that address the termination of the beneficiary spouse's interests in the event of a marital dissolution. Without such provisions, the beneficiary spouse may continue to receive distributions from the trust even after the divorce, which could be contrary to the grantor spouse's wishes and intentions. A well-drafted SLAT should include language that automatically terminates the beneficiary spouse's interests upon the filing of a divorce petition or the entry of a final divorce decree.

SLAT's Tax Considerations

There are several tax implications that must be considered when establishing a SLAT.

Step-Up in Basis

When assets are transferred to a SLAT, they do not receive a step-up in basis upon the grantor-spouse's death, which can result in potential income tax consequences for the beneficiaries. Since assets in a SLAT are not included in the grantor-spouse's taxable estate, they do not qualify for the step-up in basis. Consequently, when the beneficiary-spouse or other beneficiaries sell assets that have appreciated in value since being transferred to the SLAT, they may be subject to capital gains taxes on the entire appreciation, dating back to the grantor-spouse's original cost basis.

For example, consider a scenario where Spouse A transfers 1,000 shares of stock with a cost basis of $50 per share to a SLAT for the benefit of Spouse B. At the time of the transfer, the stock is valued at $100 per share. Years later, when A passes away, the stock has appreciated to $200 per share. If B decides to sell the stock after A's death, B will be subject to capital gains taxes on the $150 per share appreciation, as the stock's cost basis remains at A's original $50 per share, rather than receiving a step-up to the $200 per share fair market value at the time of A's death.

This lack of basis adjustment can be a drawback for assets with significant appreciation potential, as it may result in a higher income tax burden for the beneficiaries. When considering which assets to transfer to a SLAT, grantors should carefully weigh the potential estate tax savings against the possible income tax consequences for the beneficiaries. Assets with a high cost basis relative to their fair market value may be more suitable for SLAT transfers, as the potential capital gains tax liability upon sale would be lower.

In some cases, grantors may opt to transfer assets with a low cost basis to a SLAT if the potential estate tax savings outweigh the future income tax consequences. For instance, if A and B's estate is significantly above the estate tax exemption amount, transferring a highly appreciated asset to a SLAT may still be advantageous, as the 40% estate tax rate would likely be higher than the long-term capital gains tax rate that B would face upon selling the asset.

To mitigate the potential income tax consequences, grantors may consider transferring a mix of assets to the SLAT, including some with a high cost basis and others with a low cost basis. This diversification can help balance the estate tax savings and potential capital gains tax liability. Additionally, grantors may explore other estate planning strategies, such as grantor retained annuity trusts (GRATs) or intentionally defective grantor trusts (IDGTs), which may offer different tax advantages depending on the specific situation.

Lifetime Gift Tax Exemption

SLATs enable high-net-worth couples to capitalize on the current generous gift tax exclusion. In 2024, the federal lifetime gift and estate tax exemption stands at $13.61 million per individual or $27.22 million per married couple. This presents a unique opportunity for affluent individuals to transfer substantial assets to SLATs without incurring gift taxes, potentially removing millions of dollars from their taxable estates. For example, John and Sarah can each establish a SLAT for the other, transferring up to $13.61 million per trust, thereby removing a total of $27.22 million from their combined taxable estates without paying gift taxes. A couple with a $30 million combined estate can create similar SLATs, transferring a total of $27.22 million to the trusts and effectively reducing their taxable estate to $2.78 million.

Taxes in Case of Divorce

In the event of divorce, if the beneficiary-spouse remains a beneficiary of the SLAT, the grantor-spouse may continue to be responsible for paying income taxes on the trust's income under the spousal unity rule outlined in IRC Section 672(e). To mitigate this potential burden, the SLAT should include provisions that allow for the reimbursement of the grantor-spouse by the trust for any income taxes paid on the trust's behalf.

Disadvantages of SLATs

While SLATs offer numerous benefits, it's essential to weigh their potential drawbacks carefully. One significant disadvantage arises if the beneficiary spouse passes away; in this scenario, the trust assets will be distributed according to the trust's provisions, which may involve transferring the assets to secondary beneficiaries, such as the couple's children or grandchildren. Consequently, the grantor-spouse loses indirect access to the trust distributions. Similarly, in the event of a divorce, the grantor spouse may no longer indirectly benefit from the trust assets. The beneficiary spouse will continue to receive distributions as outlined in the trust terms, or if the trust includes a provision terminating the beneficiary-spouse's interest upon divorce, the secondary beneficiaries will start receiving the distributions instead. In either case, the grantor-spouse forfeits indirect access to the SLAT distributions.

Spousal Lifetime Access Trusts have emerged as a powerful tool for high-net-worth individuals and couples to minimize estate taxes and protect their wealth for future generations. However, it requires careful planning, consideration, and drafting to ensure that the grantor-spouse's rights are thoroughly protected in all unforeseen circumstances. Should you need assistance in estate planning or the drafting of a trust, we at the Law Offices of Albert Goodwin are here for you. We have offices in New York City, Brooklyn, NY and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].