Stephanie Fierro 0000-00-00 00:00:00
Spousal Limited Access Trusts: Have Your Cake – But Let Someone Else Eat It In 2009, the consensus among estate planning attorneys was that while we didn’t know where the estate tax would end up, we did not expect the government to actually let it drop to 0%. But, they did let the rate disappear for 2010. In 2011, the estate tax came back at a new historically low rate of 35% with the added bonus of a dramatically increased exemption amount of $5 million. But that reduced rate will “sunset” on December 31st of this year, and we are once again left wondering what the government will do about estate tax. Frankly, no one knows. But, what we do know is what can be done before January 1, 2013 to take advantage of the current exemption amount. The Dilemma For wealthy American families there is a rapidly closing window of opportunity to implement a wealth transfer strategy that can remove up to the current exemption amount from their estate for tax purposes. What the estate tax will look like beginning next year remains a mystery. If it changes, it is fairly likely that the exemption amount will be reduced. The sunset exemption rate beginning in 2013 is $1 million if Congress fails to act. In order to take advantage of the presumably expiring exemption amount, most strategies require the grantor to relinquish control of their assets. That is because the property actually has to move out of your estate. The two primary means for accomplishing that objective are to unequivocally gift property away or to transfer property to an irrevocable trust without a retained interest. The rigidity required is cause for concern for those who fear they may need the property at some point in the future. But if the would-be grantor keeps the property the estate may wind up owing hundreds of thousands of dollars or more in estate tax. The SLAT Proposal What if the grantor could remove property from his or her estate for tax purposes but enjoy the indirect benefit of the funds and have access to the funds if needed? In response to the scheduled expiration of the current exemption amount (and grantor fear of losing access to the funds entirely), there is renewed interest among those planning for families with substantial wealth, in a form of irrevocable trust known as a “spousal limited access trust” or “spousal lifetime access trust” also known as “SLAT”. The Structure Here’s how it works. One spouse, the grantor spouse, establishes an irrevocable trust designating the non-grantor spouse and their children as beneficiaries and nominating an independent third party to serve as trustee. The primary beneficiary of the trust is the non-grantor spouse and the children are the remainder beneficiaries. During the non-grantor spouse’s lifetime, the trustee can make discretionary distributions to the non-grantor spouse as permitted by the trust. The trust will limit that permission to the discretionary standards of health, education, support and maintenance. But the non-grantor spouse can also take limited annual withdrawals from the trust if needed or desired. These withdrawals must be limited to ensure that trust assets do not become includable in the non-grantor spouse’s estate. Further, the grantor spouse is permitted to borrow trust assets. Keep in mind, that funds borrowed are a loan that must bear interest and must be repaid to avoid inclusion in either spouse’s estate. As you can see, this form of trust permits a desirable amount of flexibility within an irrevocable structure. The Tradition Traditionally, these trusts have been funded by annual exclusion gifts. Utilizing this annual exclusion amount funding formula the grantor was able to preserve his or her lifetime exemption amount. The gifted funds were then used to pay the premiums on a second-to-die life insurance policy owned by the trust. This formula worked really well for two primary reasons. First, when the exemption amount was only $1 million it was very important to preserve as much of that lifetime exemption amount as possible. Second, the proceeds of the insurance policy could be used to pay any resulting estate tax liability at the surviving spouse’s death. Some tax could be expected as a result of the relatively low exemption amount. Now, in 2012, we have a $5.12 million dollar exemption amount that is scheduled to be reduced to $1 million in 2013. The Revival We have to assume that the exemption amount will be drastically reduced. And, since drastic times call for drastic measures, using the annual exclusion amount won’t get the job done this time. So SLATs are instead being funded with any unused portion of the grantor’s unified exemption amount up to $5.12 million dollars. Presumably, this gift will exceed the annual exclusion amount and a gift tax return will need to be filed. Normally filing a gift tax return is undesirable, but here it will record the use of the current exemption amount. So even if the exemption is later reduced, its timely use will preserve its current benefit. The Pros In addition to the tremendous estate tax benefits discussed above, assets transferred to a SLAT enjoy tax free growth inside the trust, are protected against the claims of potential creditors of either the grantor or the beneficiaries and can be enjoyed by the family, even by the grantor, if need be. The Cons First, funds going into and out from the trust must be separate property which can be a challenge in a community property state like Arizona. Second, the non-grantor spouse should be the spouse with the longer life-expectancy but if that spouse dies first the funds become essentially inaccessible. Also, it is recommended that only one spouse create a SLAT. This is so because the IRS may well attack dual trusts based on the reciprocal trust doctrine. A successful attack would treat each spouse as having set aside assets for himself or herself and no tax savings would be achieved. For purposes of this article, this strategy is being discussed in the context of the scheduled expiration of the exemption amount. As noted above, however, this can be a useful estate planning vehicle regardless of the estate tax exemption amount. In cases of larger estates, the pros of this strategy will likely outweigh the cons for those families.
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