Client calls are coming in droves regarding the need to engage in estate planning if Joe Biden wins the White House and the Democrats have a majority in the Senate. And for good reason. There is every reason to think that the currently high estate tax exemptions will be substantially reduced as part of a tax overhaul relatively early in a Biden Administration.
The estate (and gift) tax exemption for 2020 is $11.58 million per person, or just over $23 million for a married couple. The educated guessers are assuming that the exemption will go down to around $5 million per person, or perhaps even lower based on Biden’s campaign materials. But, most agree that there will be no “claw back” if the exemption is used today and then goes down next year, meaning that once the high exemption is used a taxpayer will not be penalized in future years that have a lower exemption.
In this uncertain tax environment, a “SLAT” may be an ideal tool. SLAT stands for “spousal limited access trust.” SLAT’s are not a new idea. During the “fiscal cliff” negotiations in 2012 when we thought that the exemption was going to go from $5 million a person to $1 million a person, clients were also rushing to implement planning of this nature. Your typical irrevocable life insurance trust is also, in most cases, a SLAT. And, in any situation in which the client is holding assets that are expected to rapidly increase in value a SLAT is always a consideration regardless of the politics around the exemption.
One common impediment to a client using the exemption has been a concern over loss of control or use of the gifted assets. That is where SLAT’s come into the picture. The idea is that one spouse transfers their exemption amount into an irrevocable trust for the benefit of the other spouse. As long as the other spouse is a beneficiary of the trust and as long as the couple is married, the other spouse can receive distributions from the trust as and when needed to support lifestyle or other appropriate purposes, and both spouses can benefit by virtue of being together. Still, since the assets inside the trust can grow free from any future gift or estate tax, we recommend that clients think of these funds as the last dollars they will be spending, and in the perfect world we look for long term growth assets to fund the SLAT’s.
Another concern is that once the beneficiary spouse dies, the spouse who established the trust can no longer enjoy any benefits from the trust. To address that we typically recommend that each spouse set up a trust for the benefit of the other spouse. In this way, if one spouse dies the surviving spouse can still have access to the value of the assets funding the trust set up by the deceased spouse. A similar concern arises on divorce, which necessarily results in each spouse losing access to some or all of the trust funds. The trusts could be drafted to allow for the divorced spouses to each continue to benefit from the trust set up for their benefit.
Older clients have a third possible concern in the use of SLAT’s. Under current law one receives a step-up in basis to fair market value on capital assets on death. If someone is holding very low basis assets relative to fair market value, it may make sense to hold those assets until death to receive the step-up. The client’s CPA can easily run those numbers to determine whether utilization of the gift tax exemption or utilization of the step-up is more beneficial in any given situation. The Biden tax plan proposes eliminating the step-up on death, but it is far from clear that such a proposal would ever actually pass. Anticipation during the tax bill negotiations that the step-up will actually be eliminated would certainly weigh toward using exemption right away.
Other factors could weigh into whether and how to engage in the planning, including the need to obtain a valuation of assets and the possible availability of valuation discounts for gift tax purposes, the nature of the client’s assets, the need for ongoing management control for closely held assets, and others. Still, all of these issues can be addressed through a well-crafted plan. Accordingly, this is the ideal time (and maybe the necessary time) to be exploring SLAT’s.