As President Biden and the new administration move to implement their plans and programs, we are hearing more about potential tax changes, including increasing taxes on the affluent, and in particular, estate taxes. With the majority of the U.S. population seemingly in agreement with the idea of increasing taxes on the wealthy, Congress could pass legislation this year or in 2022 that includes a provision under consideration for reducing the current estate tax and lifetime gifting exemptions of $11.7 million per person. To assume those exemptions will stay in place and fail to take advantage of current opportunities to protect your wealth could prove costly.
Consider a married couple with a net worth of $22 million. Under the current tax law, each individual could gift $11 million of their assets to a trust, thus getting all $22 million out of their estate with no gift or estate tax. A current administration proposal would limit the couple’s exemption to $3.5 million each, leaving the remaining $15 million in their estate taxable at 45 percent, an estate tax bill of $6.75 million. Their $22 million legacy would be reduced to $15.25 million, effectively making the IRS a 30 percent beneficiary of their estate.
The couple does have planning options, ways to maximize their legacy while retaining access to their wealth, including a strategy known as Spousal Lifetime Access Trusts (SLAT). A SLAT is an irrevocable trust created by one spouse, the so-called “donor spouse,” for the benefit of the other spouse and/or other family members, like children and grandchildren, the “beneficiary spouse.” The donor spouse can make gifts of separate property to the SLAT, using the lifetime gift tax exemption, typically for large amounts, or annual exclusion gifts, up to $15,000 in 2021.
The benefit of SLAT assets is that they are excluded from the taxable estates of both spouses, if structured properly. The structures can be designed many different ways, the most common being the beneficiary spouse as sole lifetime beneficiary; the beneficiary spouse and children as lifetime beneficiaries; and the beneficiary spouse defined generically, that is, whomever the donor spouse is currently married to.
Again, consider the husband and wife with a $22 million net worth. Each spouse gifts their $11 million lifetime exemption amount to a SLAT for the benefit of the other spouse. Two trusts are used because the donor spouse cannot benefit directly from the gift, only the spouse receiving the gift. The receiving spouse can be the trustee of the trust of which he or she is beneficiary as long as access to the assets is restricted according to the so-called HEMS provision, which provides that the receiving spouse can only have access to the assets for health, education, maintenance, and support—in essence, use the assets to support their current lifestyle.
In a real-world scenario, you would not likely commit all your assets to this strategy, but allow for some flexibility in the use of your assets. However, the SLAT strategy allows for the spouses to pass away at any time with no taxable estate, leaving their $22 million legacy in trust.
While the SLAT is an excellent planning tool it does come with certain risks. The gift to the trust is irrevocable so you cannot undo the transfer, the trust is subject to current tax laws and as we know those can change at any time, and divorce or death could leave some assets inaccessible or otherwise derail the intent of the plan. Still, these risks can be mitigated with thorough planning and careful design.
Of course, there is another popular option for avoiding potential increases in estate taxes. Just spend the money. Intending to spend their last dollar with their last breath is not an unusual estate planning goal, or as I’ve heard it put, the perfect estate plan is to have the check to the funeral home bounce.
A SLAT is just one of many options available to you to protect your assets now and for your heirs and customizable to suit your particular situation. Consult your financial planning professional for all the details.
IMPORTANT DISCLOSURES
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
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