By Jay E. Rivlin and Toni Ann Kruse
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended the Bush tax cuts for two additional years. Under the act, the gift tax exemption is at a high of $5.12 million per donor ($10.24 million for spouses who elect to split gifts). These provisions expire on December 31 and, absent Congressional action, the exemption will revert back to $1 million on January 1.
Many clients are eager to take advantage of this opportunity to efficiently pass wealth to their children and possibly further generations but are hesitant to part with such a significant portion of assets, which, in some cases, may impact their future cash flow. For these clients, spousal lifetime access trusts (SLATs) are very often the answer.
SLATs provide clients with the ability to use their gift tax exemption to fund a discretionary irrevocable trust for the benefit of their spouse and descendants but, because both spouses create such a trust, the couple potentially has access to the funds in the SLATs.
In most instances, each spouse will create a trust to benefit the other as well as their children and/or further descendants with the intent that neither spouse ever access the assets held in these trusts so the assets may be held and invested for eventual distribution to future generations. However, the escape valve is built in so that if, due to unforeseen circumstances, the couple needs to access the funds in these trusts, each spouse may receive distributions from the trust on which they are a permissible beneficiary.
In order for SLATs to be effective, it is important to avoid scrutiny by the Internal Revenue Service on the basis of the "reciprocal trust doctrine." If it is found that the SLATs are too similar so as to be deemed "reciprocal trusts," the entire transaction will collapse and be viewed as if each spouse made a gift to himself or herself.
To avoid such a result, the two trusts must be objectively viewed as two distinct transactions. As such, practitioners must take care to draft the two indentures with varying terms. This may be accomplished by incorporating some or all of the following suggestions:
naming an independent third party (i.e., no member of the donor's family) as the trustee on one or both trusts;
varying the distribution standards (i.e., one trust provides the trustee with full discretion, the other provides distributions only for health, education, maintenance and support);
differing the beneficiary classes (i.e., one trust benefits spouse #1 and issue, the other benefits spouse #2 and grandchildren and further descendants); or
incorporating other distinct terms (i.e., one trust provides the surviving spouse with a power to direct the assets to a specified beneficiary class; create and fund each trust on a different date; different termination dates, etc.).
These gifting opportunities expire soon so the time to act is now.
Jay E. Rivlin and Toni Ann Kruse are attorneys at McDermott Will & Emery LLP.