“Everyone is talking about the TCJA sunset after 2025, in particular the federal estate tax exemption which will be halved after 2025 assuming Congress and the President take no action. Many clients are considering gifting assets into trusts to take advantage of the currently high exemption before 2026. Perhaps the most popular irrevocable trust these days is the Spousal Lifetime Access Trust (SLAT), which has the non-gifting spouse as a trust beneficiary and allows the gifting spouse to have indirect access to trust assets through the beneficiary spouse.

Between now and December 31, 2025, thousands of couples will be confronted with the challenge of funding SLATs while maintaining cash flow for the remainder of their lives. The issue of creating non-reciprocal SLATs is truly a challenge with an unknown outcome. The answer to whether both spouses creating SLATs falls under the reciprocal trust doctrine may not be revealed until tax litigation ensues in the far future, perhaps decades away, as couples pass away. In the meantime, couples need to gift their unified credit and fund trusts.

This is where the Caveman SLAT comes in. In the Caveman SLAT strategy, a married couple analyzes the cash flow needed for the rest of their lives and funds SLATs with a sufficient amount (but not all) of their exemptions. The remaining exemption is gifted into a typical dynasty trust (not a SLAT). If later the SLATs are collapsed and included in the couple’s taxable estates, only the $2,000,000 should be included and not the entire $13,610,000 exemption.”

Robert Keebler, Michael Geeraerts and Jim Magner provide members with commentary that examines the Caveman SLAT. Members who wish to learn more about this topic should consider joining Bob and Michael in their exclusive LISI Webinar titled: “Financial Structuring to Mitigate the Risk of the Reciprocal Trust Doctrine, Including the Caveman SLAT” on August 16th @ 2PM. Click this link to learn more or register: Caveman SLAT.

Robert S. Keebler, CPA/PFS, MST, AEP (Distinguished) is a partner with Keebler & Associates, LLP and is a 2007 recipient of the prestigious Accredited Estate Planners (Distinguished) award from the National Association of Estate Planners & Councils. He has been named by Forbes as one of the 2024 Americas Top 200 CPAs, by CPA Magazine as one of the Top 100 Most Influential Practitioners in the United States and one of the Top 40 Tax Advisors to Know During a Recession. Mr. Keebler has been a speaker at national estate planning and tax seminars for over 30 years including the AICPAs: Estate Planning, High Income, Advanced Financial Planning Conferences, ABA Conferences, NAPEC Conferences, The Notre Dame Estate Planning Conference and the Heckerling Estate Planning Institute.

Michael Geeraerts, CPA, JD, CLU^®, NQPC^TM is an Advanced Markets attorney at Equitable Financial Life Insurance Company.^[1] Prior to joining Equitable, Michael was an Advanced Markets attorney at The Guardian Life Insurance Company of America. Prior to Guardian, Michael was a manager at PricewaterhouseCoopers LLP and a tax consultant at KPMG LLP.

Jim Magner is an advanced planning attorney at The Guardian Life Insurance Company of America^®.^[2] Jim previously worked as an attorney advisor in the IRS’s Office of Chief Counsel in Washington, D.C., where he wrote private and public rulings on estate, gift, GST and charitable remainder trust issues.

Here is their commentary:

EXECUTIVE SUMMARY:

The increased federal estate tax exemption under the TCJA is set to sunset after 2025, so absent legislative action prior to the sunset the exemption will be reduced to ½ of its then-indexed-for-inflation amount. The 2024 federal estate tax exemption is $13,610,000, or $27,220,000 for a married couple. The 2026 estimated projected federal estate tax exemption is about $7,000,000, or about $14,000,000 for a married couple.

Many couples with taxable estates will want to use their exemptions before 2026 and many of them will want to create two SLATs, one for the benefit of the husband and one for the benefit of the wife. However, when both spouses create SLATs, especially under a mad rush in the year before the sunset as part of an interrelated plan, the reciprocal trust doctrine becomes a real issue.

SLATs, especially the reciprocal kind, may be ripe for future litigation. The IRS sees the planning taxpayers are doing, and the Service will follow the money going into SLATs to determine if additional tax revenues can be raised. Since the exemption has reached its highest level, much money has poured into SLATs, making them prime targets for IRS attack.

The Caveman SLAT strategy is a hedge against a potential reciprocal trust doctrine attack. With a Caveman SLAT, the spouses gift a minimum, but sufficient, amount into the SLATs and gift the rest of their exemptions into a regular dynasty trust that may not be subject to a reciprocal trust attack.

COMMENT:

Spousal Lifetime Access Trust (SLAT)

A SLAT is a trust in which the grantor spouse names his or her spouse as a trust beneficiary, often the primary trust beneficiary while the spouse is alive. The grantor spouse uses his or her gift tax exemption to fund the SLAT with the intention that the trust assets won’t be included in either spouse’s gross estate. A prime benefit of SLATs is that the beneficiary spouse has access to the trust assets based on the trust’s terms, providing the grantor spouse with indirect access to the trust assets through his or her spouse.

Beneficiary spouses can be trustees if their power to make distributions to themself is limited to distributions based on an ascertainable standard, such as health, education, maintenance, and support (HEMS). If there is an independent trustee or co-trustee, that trustee could be given the power to make fully discretionary distributions for any reason. The SLAT would also include children and other descendants as beneficiaries.

Part of the reason why both spouses may want to create SLATs is the issue of a spouse’s premature death. Upon the death of the spouse who is the trust beneficiary, the grantor’s indirect access to trust assets through the spouse would end. While the SLAT could allow the trustee to loan money to the grantor as a way to access trust funds, this may not always be an ideal option. Thus, some spouses should create SLATs.

Life insurance is often owned in SLATs. One benefit of having single life policies in each SLAT is that if one spouse dies prematurely, life insurance proceeds are paid into the deceased spouse’s SLAT for the benefit of the surviving spouse and the other trust beneficiaries. The surviving spouse could then receive distributions of tax-free life insurance proceeds from the deceased spouse’s SLAT.

There are additional benefits to including life insurance in SLATs. SLATs are generally grantor trusts for income tax purposes, unless they are specifically drafted to be non-grantor trusts. Most SLATs are grantor trusts. While the grantor pay the income tax on the SLAT’s taxable income allows the trust assets to grow uninhibited by income tax, the grantor’s income tax burden can become onerous depending on the trust’s taxable income. Life insurance policy cash values grow tax-deferred and the trustee can access policy cash values tax-free through withdrawals up to basis and/or policy loans. Upon the insured’s death, the trust receives the tax-free death benefit.

Further, assets gifted to a SLAT are removed from the grantor’s gross estate and those assets generally will not get a step-up in basis at the grantor’s death. While there was some debate as to whether assets in an irrevocable grantor trust could obtain a step-up in basis upon the grantor’s death, Revenue Ruling 2023-2 held that there is no step-up in basis because the assets are not included in the grantor’s gross estate. Some practitioners may still debate this and argue there should be a basis step-up, however, it seems clear that the IRS’s position is that there is no basis step-up. Life insurance pays an income tax-free death benefit upon the insured’s death, which can act like a de-facto step-up in basis. Therefore, cash value life insurance can help grantors of SLATs reduce their personal taxable income and the death benefit on the SLAT owned policy is removed from the grantor’s gross estate and provides a step-up in basis alternative.

Divorce may be a concern with SLATs. Many modern trusts state that the beneficiary spouse will cease to be a trust beneficiary upon a divorce. The trust could also define “spouse” as the person the grantor is married to from time to time, so that upon the grantor’s remarriage the new spouse may be a trust beneficiary providing the grantor with indirect access through the new spouse. Drafting attorneys and clients may also want to consider how setting up SLATs could impact equitable division of assets upon a divorce. In any case, couples who are seriously considering a divorce are not likely going to create SLATs. SLATs are generally for “happy”^[3] marriages.

Reciprocal Trust Doctrine

At a simple level, if husband creates a trust for the benefit of wife, and wife creates a substantially identical trust for the benefit of husband, the reciprocal trust doctrine could result in uncrossing the trusts so that husband and wife will each be treated as the grantor of the trust for his or her own benefit, resulting in the trust assets being included in the spouses’ gross estates.

In Lehman v. Commissioner,^[4] two brothers created identical trusts for the benefit of one another and their descendants. Upon the death of the first brother to die, the court uncrossed the trusts and ruled that the property the deceased brother could have withdrawn from the trust created for his benefit was includable in his estate. The court found the brothers engaged in a quid pro quo where the brothers were considered to have paid one another to create a trust for their own benefit. According to the court, “a person who furnishes the consideration for the creation of a trust is the settlor, even though in form the trust is created by another.”

In United States v. Grace,^[5] a decedent transferred assets to a trust that directed the trustees to pay the decedent’s wife all the trust’s income, granted the trustees discretion to distribute principal to decedent’s wife, and granted the decedent’s wife a testamentary power to appoint the remaining trust property to the decedent and their children. Fifteen days later, the decedent’s wife created a trust for the decedent’s benefit that was essentially a mirror image of the trust her husband created. The Supreme Court held that the reciprocal trust doctrine applied in the case and that it only requires that the trusts be interrelated, and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been had they created trusts naming themselves as life beneficiaries.

SLATs have been very popular in recent years due to the higher gift tax exemption. But when both spouses create SLATs, which is not uncommon, the planning becomes much more complicated and could raise a reciprocal trust doctrine attack. The uncrossing of the SLATs may result in estate inclusion. While the reciprocal trust doctrine is not isolated to just SLATs and can arise in various plans, SLATs may be a prime target.

Although there is no safe harbor or a precise way to avoid the reciprocal trust doctrine, there the following measures will mitigate the exposure:

·      Use different trustees in the SLATs – for example one SLAT could have a distribution committee or an investment adviser but not the other SLAT.

·      Use different distribution standards in the SLATs – for example one spouse may only receive income for HEMS while the other spouse may be eligible for discretionary distributions of both income and principal.

·      Give one spouse a limited power of appointment but not the other.

·      Do not have the spouses end up in the same economic position.

·      Have different beneficiaries in each SLAT – for example different family members, loved ones, charities, or remainder beneficiaries could be used.

·      Situs the SLATs in different states.

·      Give one spouse a “5 by 5” power but not the other.

·      Give the beneficiaries different access or control of the trust assets.

·      Create the SLATs at different times, such as 12 or more months apart – the longer the period of time the stronger the argument will be.

·      Contribute different assets to each SLAT – for example contribute marketable securities to one SLAT and real estate to the other SLAT.

·      If the SLATs own life insurance, perhaps use different types of policies in each trust.

Dynasty Trusts

However, only future litigation will determine how to precisely draft trusts to avoid the reciprocal trust doctrine. A dynasty trust is designed to exist for hundreds of years or in perpetuity and provides a substantial legacy for current and future generations. A dynasty trust removes assets from the grantor’s and trust beneficiaries’ taxable estates and protects the trust assets from potential creditors. In addition to the grantor using his or her gift tax exemption, the grantor would allocate his or her generation-skipping transfer (GST) tax exemption because the trust will benefit future generations. The 2024 GST tax exemption is $13,610,000 and will also sunset after 2025.

Note that, unlike an unused estate tax exemption, an unused GST tax exemption cannot be ported over to a surviving spouse. Generally, a trust can only last for the period specified in the applicable state’s rule against perpetuities. This common law rule requires a trust to terminate no later than the end of 21 years after the death of the last survivor of the class of persons who are alive at the time of the creation of the trust. However, several states have modified or abolished this rule and allow trusts to last for hundreds of years or in perpetuity.

The benefits of dynasty trusts have been widely written about. A dynasty trust helps transfer wealth, manage investments, and preserve capital over a long period of time. The distribution provisions in a dynasty trust would typically be fully discretionary distributions. The spendthrift provisions in the trust should protect the trust assets from creditors. The trust beneficiaries are usually children, grandchildren, and future generations who may not even be born yet. At least one trustee must reside in the state where the trust is located and typically a corporate trustee should be used because of the long-term nature of the trust.

While a SLAT can certainly be setup as a dynasty trust, in the Caveman SLAT strategy the dynasty trust would not be a SLAT and would be separate from the SLATs the couple create. The idea is for the couple to create a dynasty trust that they are not beneficiaries of and avoid, or at least minimize, a reciprocal trust doctrine attack with respect to the dynasty trust.

The Caveman SLAT Strategy

In the Caveman SLAT strategy, a married couple analyzes the cash flow needed for the rest of their lives and funds SLATs with a sufficient amount (but not all) of their exemptions. For example, if a 70-year old couple determines they need $100,000 per year to live on for the next 20 years, each spouse could gift $2,000,000 into a SLAT (designed not to be reciprocal) and the remaining $11,610,000 of the 2024 exemption could be gifted into a typical dynasty trust (not a SLAT). If later the SLATs are collapsed and included in the couple’s taxable estates, only the $2,000,000 should be included and not the entire $13,610,000 exemption.

The couple would not gift all their assets away and would still have assets in their estates. For example, the couple may have IRAs, qualified retirement plans, and other assets they would spend down to maintain their lifestyle. The intention is not to dip into the SLATs but to let the SLAT assets remain in the trust outside of their estates. However, in the event the couple spends all the assets in their estates or needs additional money, the assets in the SLATs could be accessed. The SLATs are not the first bucket of money the couple would dip into, but the SLATs are there in case they need them.

While the drafting attorney should draft the SLATs to minimize a reciprocal trust doctrine attack, it cannot be guaranteed that the IRS will not raise the argument or that it won’t be successful. Therefore, by minimally funding the two SLATs and using the remaining exemptions to fund a dynasty trust, this should minimize the amount of assets that may be subject to a reciprocal trust doctrine attack, leaving the dynasty trust assets protected.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Robert Keebler

Michael Geeraerts

Jim Magner

CITE AS:

LISI Estate Planning Newsletter #3136 (July 24, 2024) at http://www.leimbergservices.com. Copyright 2024 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. Our agreement with you does not allow you to use or upload content from LISI into any hardware, software, bot, or external application, including any use(s) for artificial intelligence technologies such as large language models, generative AI, machine learning or AI system. This content is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:

^[1] Life insurance products are issued by Equitable Financial Life Insurance Company (NY, NY); or Equitable Financial Life Insurance Company of America (Equitable America) an Arizona stock company with an administrative office located in Charlotte, NC. Equitable America is not licensed to conduct business in New York and Puerto Rico. Variable life insurance products are co-distributed by affiliates Equitable Advisors, LLC (member FINRA, SIPC) (Equitable Financial Advisors in MI & TN) and Equitable Distributors, LLC.

The Guardian Life Insurance Company and Equitable Financial Life Insurance Company are not affiliated companies. Robert Keebler and Jim Magner are not affiliated with Equitable Financial Life Insurance Company.

© 2024 Equitable Holdings, Inc. All rights reserved.

Financial professional use only. Not for use with, or distribution to, the general public.

GE-6822364.1 (07/24) (Exp. 07/26)

^[2] Portions of this newsletter were written by a third party. It is provided for informational and educational purposes only. The views and opinions expressed herein may not be those of Guardian Life Insurance Company of America (Guardian) or any of its subsidiaries or affiliates.

Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. Not practicing for Guardian or any subsidiaries or affiliates thereof. Equitable are not affiliates or subsidiaries of PAS or Guardian and opinions stated are their own. 2024-178682 (Exp. 07/26).

Fixed life insurance is co-distributed by affiliates Equitable Distributors, LLC and Equitable Network, LLC (Equitable Network Insurance Agency of California in CA; Equitable Network Insurance Agency of Utah in UT; and Equitable Network of Puerto Rico, Inc. in PR) and Equitable Distributors, LLC.

References to Equitable in this article represent both Equitable Financial Life Insurance Company (NY, NY) and Equitable Financial Life Insurance Company of America, which are affiliated companies. Overall, Equitable is the brand name of the retirement and protection subsidiaries of Equitable Holdings, Inc., including Equitable Financial Life Insurance Company (NY, NY); Equitable Financial Life Insurance Company of America, an AZ stock company with an administrative office located in Charlotte, NC; and Equitable Distributors, LLC. Equitable Advisors is the brand name of Equitable Advisors, LLC (member FINRA, SIPC) (Equitable Financial Advisors in MI & TN).

Equitable Financial, its affiliates and distributors and their respective representatives do not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein.

^[3] What defines a “happy” marriage varies from couple to couple, but as Joan Rivers has been quoted saying, “Half of all marriages end in divorce – and then there are the really unhappy ones.”

^[4] 109 F.2d 99 (2d Cir. 1940).

^[5] 395 U.S. 316 (1969).