Is it Time to "Use it or Lose it?"

In the wake of COVID-19, we may see significant statutory changes to the federal estate, gift, and generation-skipping transfer tax exemptions.  Spousal Lifetime Access Trusts and other planning techniques provide opportunities to effectively use our current lifetime exemptions, even in the face of continued market volatility.

The United States Congress and the Federal Reserve have been taking unprecedented steps to shore up our economy – massive stimulus packages have already made their way into law, and more appear to be coming down the pike.

Market observers are supporting this "priming of the pump" to help businesses and families make it through the coronavirus pandemic, but even as we look to the horizon and the prospect of continued pandemic-related market volatility, legal, and tax observers are noting a recurring theme: At some point, taxpayers will have to replenish the government's piggy bank.

One revenue-raising measure, in particular, may be back on the radar of lawmakers: The Estate Tax.  The Tax Cuts and Jobs Act of 2017 (the "TCJA") increased the unified federal estate, gift, and generation-skipping transfer tax exemption to $10 million per person with an annual inflationary adjustment.  In 2020, an individual can transfer – by lifetime gift, transfer at death, or a combination of the two – a total of $11.58 million to non-spouses without incurring these transfer taxes.  But the heightened exemption amounts provided for under the TCJA are set to "sunset" on January 1, 2026, at which point the previously-set $5 million baseline exemption will come back into effect.  Perhaps more importantly, Congress can change this exemption amount at any time.  You may recall that in 2009, the gift tax exemption was $1 million, while the estate and generation-skipping tax exemptions were capped at $3.5 million.  In 1999, the estate tax exemption was $650,000.

In light of our recent stimulus spending and the current political climate, many are wondering how long this exemption high-water-mark can last.  Even before the planned sunset of the TCJA, we may see Congress moving to lower the exemption in order to increase tax revenues and replenish federal coffers.  And remember, under the law's current "use it or lose it" approach, the exemption amount in effect at your death will control how much of your estate passes transfer-tax-free, unless you have engaged in lifetime transfers that "locked-in" your use of this current exemption.   Thus, it may be more imperative now than ever before for individuals facing potential estate tax liabilities to find a way to use this massive exemption amount while it is still available.

We have previously illustrated certain direct lifetime gifting strategies that can be used to effectively leverage the current available exemption, but this article will focus on an alternative technique: One that allows an individual to use all or a significant portion of the currently-available exemption to transfer assets out of his or her taxable estate, but with a "safety net" twist.  This technique will be attractive to those who are hesitant to fully divest themselves of assets that they worry may be necessary for their support in the future.

Spousal Lifetime Access Trusts

A Spousal Lifetime Access Trust ("SLAT") is an irrevocable trust created by one spouse for the benefit of the other spouse, their children, grandchildren, or any number of other beneficiaries.  Because a SLAT is an irrevocable trust and the trust creator (the "grantor") has no direct control over or beneficial interest in the trust property, assets contributed to the trust are removed from the grantor's taxable estate for estate tax purposes.  However, because the SLAT is designed to allow assets to be used for spousal support, the grantor has a certain indirect access to trust income and the underlying assets.  Distributions to the beneficiary-spouse can be, and often are, used for the support and maintenance of both spouses as a marital unit.

As with many trust structures, the grantor of a SLAT has a great deal of flexibility regarding the selection of trustee, the naming of a contingent or future beneficiaries (including descendants or charitable entities), and the discretionary standards governing trust distributions.  The beneficiary-spouse can be named as trustee, making administration relatively simple and painless.  Additional protections and powers can be added to allow the spouse or a trusted fiduciary the flexibility needed to react to changes in family circumstances over time, whether financial or personal in nature, further alleviating the angst that can sometimes be associated with creating an irrevocable trust plan.   

When a SLAT is successful, the assets placed in the trust are removed from the taxable estate of the grantor, and are not includible in the beneficiary-spouse's estate either.  Once the transfer occurs, all of the future appreciation accrues outside of the taxable estate, and generation-skipping transfers can continue for multiple generations.  The remainder beneficiaries will not receive the coveted step up in basis that would occur if the assets had been included in the grantor's taxable estate, but the loss of that benefit is often outweighed by the total transfer tax savings.

It may go without saying, but family dynamics, the strength of the marital relationship, the risk of divorce, and the relative ages of the spouses all have a role to play in determining whether the SLAT might be an effective tool for a particular family.  Certain technical legal principles, like the reciprocal trust doctrine, must also be kept in mind when drafting the trust's operative provisions.

Alternatives and Additional Techniques

"Self-Settled Asset Protection Trusts," which are analogous to SLATs but do not rely on the spousal relationship to succeed, are available in certain state jurisdictions outside of North Carolina.  These trusts can be somewhat more costly to set up and administer, in that you often need a trustee, administrator, or personal connection to the governing state in order to qualify for the desired tax and creditor treatment.

For taxpayers who have already used up a lot of their exemption, or for single individuals, there are still many other ways to leverage annual gifting, valuation discounts, and low interest rates to make lifetime transfers of assets now, while still providing for your own continued support.  For more information on these techniques, please consult our recently-circulated article introducing Grantor Retained Annuity Trusts and Installment Sales to Grantor Trusts, two particularly-advantageous techniques in this low interest rate environment.

Finding the Right Approach for You 

Considering the current economic and political state-of-things, the SLAT may be an ideal method to lock in lifetime usage of this historically high exemption amount, while still providing some protection from financial downswings.  Used independently, the SLAT is an obviously advantageous arrangement for certain married couples.  And when used in concert with the other planning techniques noted above, such as taking advantage of temporarily depressed asset values or historically-low interest rates, the SLAT can compound those benefits on a potentially large scale.  If you are interested in learning more about these planning opportunities, our Trusts and Estates team is ready to help you analyze your particular goals and identify the right techniques for achieving them.  This turbulent time may be just the right time to put the estate planning pen to paper.

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© 2024 Ward and Smith, P.A. For further information regarding the issues described above, please contact Jennifer V. Boyer.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

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