With anticipating changes in tax laws happening next year, it's time to review your estate plan to ensure it will continue to achieve your goals by minimizing estate taxes. 

The federal government currently imposes a gift tax on lifetime gifts and an estate tax on transfers on death.  A properly structured estate plan can reduce taxes by taking full advantage of the available tax exemptions, specifically the gift and estate tax "unified credit".  The unified credit permits every individual to transfer a specific amount of assets (an "exemption") tax-free either during their lifetime or at death. 

The Tax Cuts and Jobs Act of 2017 (TCJA) increased the federal gift and estate tax applicable exclusion amount (known as the gift and estate tax "exemption").  In 2017, prior to the enactment of the TCJA, the federal gift and estate and exemption was $5.49 million.  In 2021, the federal gift and estate exemption is $11.7 million.  Thus, today, a married couple can transfer $23.4 million before having to pay a gift or estate tax.  Based on the current political climate and growing deficit situation, many people anticipate the acceleration in a reduction in the exemption amount next year.  If it is reduced next year, gifting assets this year allows you to use the higher exemption amount to reduce future estate taxes.

If the federal estate tax exemption is reduced from $11.7 million per person to the range of $3.5 million and $5 million in 2022, the clients who have a combined estate of over $7 million should carefully consider various gifting strategies.  The federal gift and estate tax rates are 40% now and may go up next year.  One of several planning suggestions is gifting to a Spousal Lifetime Access Trust (SLAT) for spouses and others.  This will allow income to be paid to the donee spouse while using the available exclusion of the donor spouse.  The assets transferred to the SLAT will not be taxable in either spouse's estate.

What is a SLAT?

A SLAT is a gift from one spouse (the donor spouse) to an irrevocable trust for the benefit of the other spouse (the beneficiary spouse).  The SLAT is funded by gift while both spouses are alive, unlike the "bypass" or "credit shelter" trust.

The beneficiary spouse can receive distributions from the SLAT, yet the SLAT is designed to be excluded from the beneficiary spouse's gross estate and to not be subject to estate tax when the beneficiary spouse dies.  To prevent the value of the assets of the SLAT from being included in the beneficiary spouse's gross estate, the SLAT will not qualify for the gift tax marital deduction (either because the donor does not make the necessary election or the terms of the trust prevent it from qualifying).    This allows the donor spouse's exemption from the gift and estate tax to be applied to the value of the assets transferred to the SLAT, sheltering the transfer from gift tax.

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Although the SLAT can be drafted to require the beneficiary spouse to receive the trust's income for life, this is not necessary, allowing the SLAT to have multiple beneficiaries, such as the beneficiary spouse and the couple's descendants.

The Scenario

Suppose a married couple, John and Jane owns and runs a family business.  The business has been doing very well, and John and Jane anticipate that the value of the business will appreciate substantially over time.  They want to minimize the impact of estate taxes and implement a tax-efficient strategy to pass wealth to their children and grandchildren.  They also want to ensure that their assets are protected from their creditors and their children's creditors.  At the same time, the life expectancy of both John and Jane is at least 20 to 30 years.  While both are alive, John transfers his one-half interest in the family business to a trust for Jane's benefit.  The transfer of John's one-half interest in the family business removes the assets from John's estate and Jane's estate and therefore shields the assets from estate taxes.  The business can grow over the years without exposure to any additional estate or gift taxes on that growth.  In addition, if the SLAT is drafted properly, the asset should be protected from John's and Jane's creditors, as well as the creditors of their descendants.  Note that other types of assets may be transferred to a SLAT. 

For many families, the thought of using both spouses' full exemptions from the estate and gift tax may not be practical.  Instead, couples may find it desirable to use some of both spouses' exemptions or all of only one spouse's exemption.  For example, if the donor spouse today creates a SLAT using the donor spouse's entire exemption, the other spouse's exemption would remain available even after the sunset in 2026.  Creating a SLAT today could potentially shelter more wealth from the estate tax than would do nothing.  To illustrate: If in 2021 the donor spouse uses $11.7 million to fund a SLAT and in 2026 the exemption reverts to $6 million, were the other spouse to create a SLAT (or die) in 2026, using the exemption at that time, the couple would have exempted from estate and gift tax, in the aggregate, $17.7 million.  Had the couple not created the SLAT in 2021, and both died after the sunset in 2026, at a time with the exemption was $6 million, the total amount exempted from estate tax would be $12 million.  Accordingly, on these facts, by engaging in SLAT planning now, the couple would be able to exempt from the estate and gift tax an additional $5.7 million. 

A Note about State Estate Taxes

For Minnesotans, the state estate exemption is $3 million in 2021 and may go down next year.  Minnesota uses a graduated scale to assess an estate's tax liability and their current estate tax rates range from 13% to 16%.  It's worth noting that Governor Walz proposed to change the exemption to $2.7 million.  Therefore, you may see the benefit of gifting more this year if your combined estate is over $6 million. 

For married persons who want to take advantage of the increased exemption from the estate and gift tax, but are not sure that they can irrevocably part with so much wealth, a SLAT may be an appropriate solution.  To achieve the tax benefits, the SLAT must be an irrevocable trust.  When creating a SLAT, the donor spouse must irrevocably transfer assets to the SLAT, forever parting with the income from and use of those assets. 

For federal income tax purposes, a SLAT is treated as a "grantor trust."  This means that the donor spouse, as the grantor of the SLAT, is for income tax purposes treated as owning the assets of the SLAT.  The income from the trust's assets is included in the donor spouse's gross income, requiring the donor spouse to pay income tax.  Because the donor spouse is obligated to pay the income tax attributable to the trust's income, this tax payment is not a gift to the trust (and is not subject to gift tax).