What Are The Potential Disadvantages/Pitfalls Of A SLAT?
While the use of a SLAT can be a good tax planning tool there are some disadvantages to this type of trust. The donor spouse must give up all control over the property placed in the trust, cannot be the trustee, and cannot request distributions from the trust. For example, if the trust allows distributions to the spouse and children, in the trustee’s discretion, the trustee could choose to only make distributions to the children, bypassing the spouse completely. The donor spouse also cannot change the beneficiaries or their interests after the creation of the trust.
SLATs will also likely be considered a “grantor trust” for income tax purposes, which means the donor spouse will be taxed on any income generated from the trust on his or her individual income tax returns, even though the donor spouse receives no benefit from the trust assets.
Finally, the trust funds will not be eligible to receive a “step-up” in basis upon the Donor’s death. As with any gift, assets transferred to the trust will maintain the Donor’s cost basis and capital gains tax will be applied when the trust assets are transferred or sold. The donor spouse should carefully consider the type of property they want to put into the trust prior to making such a transfer to make sure it complies with the family’s overall estate plan.
The primary pitfall for the creation of SLATs is known as the reciprocal trust doctrine.
Spouses may each want to create a SLAT for the benefit of the other spouse to take advantage of both spouses’ unified credits. The reciprocal trust doctrine states that the full value of a trust will be considered property of the donor’s estate when the donors create two interrelated trusts that leave the donors in the same economic situation they would have been had they created trusts naming themselves as life beneficiaries (Source: U.S. v. Grace’s Estate, 395 U.S. 316, 1969). In other words, if both spouses collectively have equal access to the funds after the transfer as they did prior to the transfer, the SLATs will be nullified.
If a couple wants to create two SLATs they must be careful to draft them in a manner that avoids violating the reciprocal trust doctrine. For example, the trusts could have different distribution terms and be created in different years. Careful consideration should be taken before choosing this option.
Planning Considerations
When choosing to create and fund a SLAT, the donor should consider what assets will be needed to support his or her lifestyle and make sure to not include those assets in the trust. Another, less pleasant, item to consider is the strength of the marriage. This type of trust is irrevocable and as such cannot be undone. If there is a divorce, the beneficiary spouse may have control over the property, and it may be difficult to divide the assets.
If the donor spouse wants to give the beneficiary spouse a power of appointment, especially in a second marriage situation, it is important to consider who the beneficiary spouse will be allowed to appoint the property to in such a situation. If not drafted carefully, the beneficiary spouse could appoint the property to his or her children from a prior marriage or in the event of a divorce and remarriage, to a new spouse, which may not be the intent of the donor spouse.
Conclusion
While there are many advantages to creating and funding a SLAT, there are a few pitfalls. Contemplating the future needs of the family and potential for a breakdown of the family is important before creating this type of trust. A qualified estate planning attorney should be consulted to implement a wealth planning strategy that includes SLATs.
Katharine B. M. Brite is an associate at Boston law firm Rackemann, Sawyer & Brewster where she concentrates her practice in all aspects of trusts and estates law. She represents clients in matters involving estate planning, estate and probate administration, trust management, and tax planning.
Matthew J. Leonard is a director at Boston law firm Rackemann, Sawyer & Brewster. His practice focuses on the areas of estate and gift planning, estate and trust administration, charitable planning, probate litigation and business succession planning. He assists individuals and families in planning and carrying out comprehensive gift strategies and estate plans to transfer and protect family wealth in a tax-efficient matter tailored to the client’s wishes.