The Time Is Now: Estate Planning Before Sunset (of the Federal Estate Tax Exemption)

Time, as they say, flies, and in the near future, high net worth families may be hit with heavy taxes if they choose to gift generously to their children. Right now, thanks to the Tax Cuts and Jobs Act of 2017 (the Act), high net worth couples can currently make substantial gifts to their offspring without incurring estate or gift tax.  But nothing lasts forever.

The current law which allows you to gift $11.58 million individually or $23.16 million as a married couple is set to sunset at the end of 2025. Come January 1, 2026, the unified credit amount will revert to pre-2018 levels (indexed for inflation). Comparatively, that means a disappointing $6 million if you are a single donor or $12 million if you are gifting with your spouse.

With the Biden administration set to move into the White House in January and potential changes in Congress on the horizon, the Act could come to an end even sooner. What’s more, even though New Jersey’s estate tax was repealed effective January 1, 2018, there have been calls to revive the tax, creating another potential hit that will put your assets at risk.

This means there is no time like the present to take action and put your head together with your financial advisor, CPA and estate attorney, in order to make sure you take advantage current laws prior to the 2025 sunset of the Act. Gifts that take advantage of the exemption now as well as their future appreciation are shielded from future estate and gift taxes that are coming down the pike with changes in the tax law. A Spousal Lifetime Access Trust (SLAT) may be the ideal vehicle to protect your assets for your heirs now and in the future.  A SLAT can also shield your assets from your creditors.

The SLAT can accomplish two important objectives. The donor can make a gift to a donor-spouse as well as to future generations. The donor can also benefit from the assets in the trust during the donor’s lifetime.  You can fund the trust with various assets. Any assets not used to support the beneficiary spouse’s lifestyle remain in the trust for beneficiaries in future generations. As with most irrevocable trusts, future appreciation on the assets is protected from transfer taxes.

Still, couples may be reluctant to make outright gifts to their grown children, because they fear they will lose control over funds that they will end up needing as they age. But a SLAT trust takes care of that, because it is an irrevocable trust in which one spouse makes a gift into a trust to benefit the other spouse and potentially other family members. At the same time, a SLAT removes the assets from their combined estate. 

The ultimate goal of the SLAT should be to let the trust assets grow outside the estate for future generations.  When the non-donor spouse dies, the SLAT’s assets are transferred to the remaining trust beneficiaries (e.g., the children or grandchildren). These assets can be transferred in trust or outright.

It’s important to determine the appropriate amount to gift to a SLAT. Proper budgeting planning and forecasting are also imperative. Meticulous attention upfront will enable you to properly benefit from the SALT’s designed goal to both remove the assets from the donor’s taxable estate and appreciate in the SLAT outside it.

To avoid income tax to the trust, SLATs are typically structured as grantor trusts.  In other words, rather than the trust itself bearing the burden of paying income taxes, the donor pays the income tax liability personally on the earnings generated in the trust.  This structure allows the assets inside the trust to grow outside of the estate of the donor and, with the donor paying income taxes on the trust’s earnings, the beneficiaries receive the trust assets free from income tax in the future.  The donor’s income tax payment on the income tax on the trust has the additional benefit of further reducing the donor’s taxable estate.

Divorce and/or death of the non-donor spouse can compromise the SLAT strategy because in either of these situations, the donor spouse no longer has indirect access to the trust assets. On the one hand, in the event of death of the non-donor spouse, the trust may either terminate and be distributed to or continue for the benefit of the donor’s children and other family members, a goal of establishing the trust in the first place.

But in the event of divorce, the separated non-donor spouse will continue to benefit from the trust as a beneficiary while the donor spouse loses indirect access in the same way they would if the non-donor spouse passed away while they were still married. Because one of the greatest utilities of a SLAT hinges on a spouse as a primary beneficiary, divorce has the effect of cutting off a donor spouse’s indirect access to the SLAT. 

Properly structuring the trust can mitigate the divorce risk. For example, one workaround designates the termination of the non-donor spouse’s beneficial interest in the trust in the event of divorce. That said, there’s no question that the SLAT works best when estate planning and marital income needs are aligned and coordinated. So your SLAT must be carefully structured to avoid violating the reciprocal trust doctrine. That doctrine was judicially designed to prevent two parties from creating trusts for each other to ensure that each party benefit from lifetime enjoyment of property while avoiding inclusion in both gross taxable estates.