- The exemption is temporary and will drop by ½ in 2026 under current law.
- If there is a change in power in Washington (no predictions here, my Ouija Board has burnt out) the exemption could drop precipitously well before 2026. But consider this, whatever happens politically, the massive coronavirus bailouts will have to be paid for. Taxes may have to go up regardless of the political situation. That last point should motivate any one with wealth to plan now.
- Setting up irrevocable trusts now may provide asset protection benefits (i.e. protect assets transferred from malpractice claims and other suits). All the growth in the assets will be removed from your estate as well. We live in an incredibly litigious society and nothing tax-wise that happens in Washington is likely to change that. So, even if the Dems don’t take over and the tax laws don’t change, planning to use exemption can provide you with great asset protection.
- Using your exemption prudently, by assuring you have access to the funds transferred out of your estate in case you need them in the future, is likely to be a wise move. Access is essential for most people now given the fears of what might happen with the economy and the substantial reduction in wealth many people have realized in early 2020. In 2012 when it was anticipated that the exemptions would drop from $5 million to a mere $1 million in the following year, lots of people set up trusts. In too many instances those trusts were designed to benefit only children or later descendants. What about benefiting you? Many who set up those trusts later regretted doing so. Not just because the exemption did not decline as feared, but mostly because they lost any access to their own funds. Don’t make the same mistake.
- If you’re married, you can set up a trust that your spouse is a beneficiary of. That way your spouse can access assets transferred as a beneficiary and you don’t lose the ability to benefit from the wealth you accumulated. Generally, that’s a much smarter approach that what a lot of folks did in 2012 when planning for the possible reduction of the exemption. These trusts are sometimes called Spousal Lifetime Access Trusts or “SLATs.”
- If you’re single you might consider some variation of what is called a self-settled trust. Sometimes these are referred to, if set up in the US, as a domestic asset protection trust, or DAPT. This is a trust that you can have access to. Specifically, if you create a DAPT you are a beneficiary of your own trust. You have to do so in one of the 19 states that permit those types of trusts for it to have a chance of working. Most folks seem to agree that if you live in one of those 19 states these trusts work. Some suggest, however, that if you live in a non-DAPT state and create a DAPT in a state that permits them, that this technique may not work. In many jurisdictions, a self-settled trust is void as to the settlor’s creditors. In New York, for example, EPTL 7-3.1 provides: “(a) A disposition in trust for the use of the creator is void as against the existing or subsequent creditors of the creator.” If you fall into that category, or perhaps just want to be more careful, there are options like Hybrid-DAPTs, special power of appointment trusts (“SPATs”) and other variations. Those are beyond the scope of this article.
How To Use Exemption Now: Checklist For Spousal Lifetime Access Trusts (SLATs)
Originally posted on Forbes.com
Reality Check: With the coronavirus spreading, the stock market crashing and the evening news instilling fear, its really hard to think about estate planning. True. But that might just be a critical step to preserving your wealth.
Use Exemption Now:
The current estate, gift and generation skipping transfer tax (GST) exemption is a whopping $11,580,000. Whether your estate is larger then that or much lower, if you can use some or all of that exemption now there are a bunch of reasons to do so:
How to Use Exemption:
So, if you’re going to take the plunge what type of plan might make sense for you?
Checklist of SLAT Considerations:
Let’s say you’re setting up a SLAT. What decisions might you want to take in crafting the document with your attorney and planning team? What ancillary steps might you want to discuss with your planners to help the plan? The checklist below will give you a starting point for those discussions.
Forecasts: Forecasts should be used to support and determine the assets you will give to the trust. For example, assets should not be transferred to the trusts that will likely be needed to support your lifestyle. Forecasts are also advisable to demonstrate that you are unlikely to need the assets transferred to the trust. That could be useful to deflect a challenge that the transfer was a fraudulent conveyance. The financial models should consider the current state of the markets and economy, your wealth, spending, income sources (e.g. a pension), etc. and help you demonstrate a reasonable amount of wealth that you might prudently transfer to your trust. Your financial picture might be such that you can transfer the entirety of your remaining exemption ($11.58 million if no taxable gifts were made in the past) to a SLAT. For others the amount will be much less. Bear in mind it is not only how much your net worth is, but how much you spend and might need that will set a cap on what is feasible to gift. So, you should have a forecast confirm what is reasonable to do. Few if any attorneys have the capabilities or software to do such modeling so this means that your CPA and/or financial adviser have to be active members of the team doing this planning with you and your attorney.
Situs: What state will you create your trust in? Most folks assume it should be the state where they live. Why? You can set up your trust in any state you choose so long as you name a trustee in that state. Why complicate matters? Because the laws are better in some states then in others, and some states have more favorable tax laws then other states. If you can, the safer route might be to create a trust in one of the 19 states that permit self-settled trusts or “DAPTs” as discussed above.
Using different states for each spouse’s trust: That can be done but requires modification to the planning and documents. If you and your spouse are both setting up SLATs you should discuss with your attorney, the benefits of using different states. For example, you might set up a SLAT for your spouse and descendants in Nevada, and your spouse might set up a trust for you and descendants in Alaska. The use of different states and different trust companies might help differentiate the trusts which may help deflect a challenge that the trusts are reciprocal (see below), which could undermine the planning. There are now 19 states that permit so-called self-settled trusts or DAPTs. It might be advisable to set up your SLATs in one of those states. Why? Let’s say your spouse sets up a SLAT for you in your home state which doesn’t permit self-settled trusts. You take a withdrawal of funds from the SLAT your spouse created for you and deposit it into a joint checking account. Your spouse uses that account to pay her personal bills. She has arguably benefited from the assets in the trust created for you which is not permitted. That might undermine the plan. However, if the trust is setup with appropriate safeguards in a DAPT jurisdiction it might survive that type of challenge. Remember the old adage, “better safe than sorry.”
Income tax treatment: In many cases the SLAT you create will be characterized for income tax purposes as a grantor trust. That means you will pay the income taxes on the trust income personally. So using a trust friendly state might give you access to better laws, but while you are alive it might not provide any state income tax savings. You should also discuss with your advisors whether your SLAT might be set up to be a non-grantor trust to save state income taxes.
Powers of Appointment: Trusts generally should include what are called “powers of appointment.” This is the right given to someone to appoint where trust property should be distributed. For example, your SLAT has a trust that permits distributions to your spouse and descendants while your spouse is alive. On your spouse’s death you give your spouse the right to designate who should get the trust assets. The trust certainly should have a default of where assets should be distributed if your spouse doesn’t act. Why give your spouse this right? It can add great flexibility. The world may be different when your spouse dies then it is now so that this flexibility is valuable. If it is a second or later marriage you might choose not to give such a power, or you might choose to restrict it to specified heirs. Even being able to exercise the power as to the terms of a trust that the heirs you limit the class of appointees to may be useful. It is common to limit a spouse’s power of appointment to a testamentary power (only exercisable on the surviving spouse’s death, e.g. under a will) and often to make the power a so-called “limited power of appointment.” This gives your spouse the right to appoint trust assets in the SLAT under your spouse’s will to anyone other than the spouse’s estate, creditors of the spouse’s estate, the spouse, or the spouse’s creditors. These limitations avoid including the trust assets in your spouse’s estate but give wide latitude as to where to appoint them. That provides considerable flexibility but also could be viewed by you as negative because your spouse could appoint to a new spouse, etc. The power of appointment given to each child (or other heir) on their death might be limited to your descendants. But you might choose to make the power broader.
Loans: Another provision to consider is granting to someone the power, in a non-fiduciary capacity, to loan you trust assets if you created the trust. Some might refer to this as a “loan director,” but other titles might be used as well. A loan director can determine to loan funds to you as the settlor of the SLAT (and to your spouse out of the SLAT your spouse creates for you) without adequate security for the loan (but the loan director might be require to charge adequate interest to avoid tax issues). The mere existence of this power may characterize the trust as a grantor trust for income tax purposes. In fact, historically that is why this power was used. But this mechanism may also provide another means for you to access trust assets should you require them. In other words, it’s a great source of flexibility and preserving access (albeit as a loan) for you to assets you might gift away now to use your temporary exemption.
Adding a Charity: You might also infuse another means of indirectly “accessing” funds in your SLAT. You might give someone the power to add charitable beneficiaries. This person might be called a “charitable director,” but other titles might be used as well. A charitable director can determine to add charitable beneficiaries to your SLAT (and to your spouse out of the SLAT your spouse creates for you). How might this provide you a means of “access” to the trust you create? If you would like to make a charitable donation the charitable director can add the charity to your SLAT and the donation can be made out of SLAT funds not your funds. However, be careful, if the SLAT pays a charitable pledge you made that would be inappropriate and could torpedo the planning. The mere existence of this power may characterize the trust as a grantor trust for income tax purposes. In fact, historically that is why this power was used. But this mechanism may also provide another means for you to access trust assets should you require them.
Vacation Home: Your SLAT could possibly own an interest in a vacation home. And if your spouse uses the vacation home, you can as well. Bear in mind if that is to be done a limited liability company (“LLC”) should be formed in the state where your SLAT is governed and administered. That LLC should be authorized to do business in the state where the vacation home is located. That LLC would own the vacation home property and in turn the trust could own some or all of the interests in the LLC. This complication would be necessary because a SLAT formed in say Delaware, could not own real property in say New York or California. But having the real property held by an LLC transmutes it from real estate to an intangible asset which a trust in a different jurisdiction can own.
Income tax: If your SLAT is structured to be a grantor trust (i.e., you pay the income tax) you might consider including a discretionary income tax reimbursement clause in your SLAT. This permits the trustee of your SLAT, in the trustee’s discretion (it cannot be mandatory) to reimburse you for income tax you pay on trust income. If you ever anticipate such a reimbursement being made consult with your professional advisers in advance to be sure that the appropriate formalities are adhered to. Also bear in mind that a tax reimbursement defeats somewhat the point of the trust as it is removing trust assets from the protection of the trust back into your estate. So, a tax reimbursement provision can add valuable flexibility and give you more comfort creating a SLAT and making large transfers during these difficult times.
Notice to beneficiaries: Generally, beneficiaries should be given notice of the existence of a trust and the assets in a trust. However, if the assets you are gifting to your SLAT are primarily for the financial security of you and your spouse, you might prefer that heirs not be informed of the trust so that they are less likely to ask for distributions until you are certain that your spouse will never need the trust assets. You might form the SLAT in a state that permits so-called “silent trust provisions.” These are states that permit the trust to include a provision prohibiting disclosures to later beneficiaries during your lifetime or your spouse’s lifetime. That may serve to limit the disclosures and information that the trustee may give your descendants. There are pros and cons to this approach. You might prefer to limit access to information during your lifetimes but that also prevents the descendants who have a strong interest in knowing the status of the trust from having information to intervene if there is a concern or problem. Some people view this as an important point of comfort to get them to the point of being willing to make large gifts.
Estate inclusion: You could give a person, acting in a non-fiduciary capacity, the right to grant or give you as the settlor of the trust, a power to control enjoyment of trust assets. This mechanism could be used, if that person exercises the power, to force any or all trust assets back into your taxable estate (under Code Section 2038). Doesn’t that defeat the point of the SLAT and all the planning? Yes, but it is another possible means of injecting further flexibility into the SLAT and your plan should estate inclusion become advisable under whatever new tax regime some future administration might enact.
Life Insurance: Many people have existing life insurance trusts (often called by the acronym for an irrevocable life insurance trust or “ILIT”). You can incorporate insurance provisions into your SLAT. That can avoid the need for yet another trust. It can greatly simplify planning. If you make a large gift to the SLAT to use exemption, then why bother making annual gifts to a separate life insurance trust? Just have the SLAT own the insurance and pay premiums. If this approach is used, you may be able to merge an existing life insurance trust into your SLAT. You should consider naming a separate life insurance trustee of the SLAT as well. Even if you do not believe you have plans to buy life insurance it is no big deal to build this flexibility in when you are creating your SLAT. It is simple to do and avoids the need to decant to add this flexibility to own life insurance if you wish you add insurance later.
Hybrid DAPT: You could add a provision to your SLAT giving an independent non-fiduciary the power to add the descendants of your grandparents (which would include you) as a beneficiary. This structure is sometimes called a “hybrid asset protection trust.” The purpose would be that if the estate tax is repealed, or your spouse dies prematurely, and you need access to your SLAT (since you are no named a beneficiary of a SLAT you create) that person at a future date could add you as a beneficiary. That could eliminate the mortality risk associated with the technique. There are risks with this technique and an increased, but unmeasurable risk that such a provision might cause estate inclusion. For example, some suggest that a case in New York might indicate that hybrid-DAPTs may also be subject to challenge. In Iannotti v. Commissioner of New York State Dept. of Health, 283 AD 2d 645, 725 NYS, 2d 866 (2001), the court held that a trust protector had the power to amend the trust and thereby make the grantor a beneficiary. Based on this power, the court ruled that the grantor’ creditors could reach the trust assets. Note, however, that the trust protector was subject to a fiduciary duty. Might having a trust protector only serving in a non-fiduciary capacity provide a different result?
Final Takers: Confirm the provision that provides who should receive trust assts if you and your spouse and all descendants die. Many documents provide as an assumed default, that on the death of the last of you and your spouse, if no descendants survive, assets pass ½ to each of your heirs at law. You might prefer instead to name specific people or charities. Remember SLATs should be set up as very long-term trusts so a broad lasting category of final takers makes sense.
Reciprocal Trust Doctrine: The reciprocal trust doctrine should be addressed with using these trusts if you create a trust for your spouse and your spouse creates a trust for you. The reciprocal trust doctrine suggests that if the two trusts are too similar (not a clearly defined concept) that the IRS or creditors could “uncross” the trusts so it will be treated as if you created a trust for yourself and your spouse created a trust for themselves. In a landmark case United States v. Grace the decedent created a trust in which his wife received the income, the trustees had discretion to distribute principal to the wife and the wife had a limited power of appointment she could exercise by will, in favor of the husband and their descendants. Two weeks later, the wife created a mirror image trust. The Supreme Court held that the reciprocal trust doctrine applied because the trusts were interrelated, “and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been if they had created trusts naming themselves as life beneficiaries.” United States v. Grace, 395 U.S. 316 (1969). The motive for creating the trusts wasn’t relevant. So, the more matters that can differentiate the trusts and planning from each other the better. Can you fund each trust at different times and with different assets? This is one of the reasons for having the trusts in different jurisdictions with different trustees. Also, when your lawyer drafts the trust documents, they should integrate legal differences in each trust instrument.
Annual Demand Powers: The Crummey Notices (notice of right of withdrawal) should be completed and delivered to all beneficiaries having such withdrawal rights. Some practitioners follow a practice of having all Crummey beneficiaries present at the time of execution of the trust, so that delivery of the notices can be contemporaneous with the creation of the trust. Any Waiver of Notice also should be confirmed by written memorandum or letter to the party responsible for sending those notices.
Assets: Please ensure that the ownership of assets intended to be held by the trust are properly transferred to the trust and registered in the name of the trust. If you have securities, you will gift to the SLAT they should be transferred to the SLAT account in the name and tax identification number of the SLAT. If you transfer entity interests a corporate attorney should draft appropriate assignments and amended and restated entity documentation reflecting the trust as owner.
Gift Tax Return: You will have to file a United States Gift Tax Return (Form 709) reporting the gifts to your SLAT. Your spouse will similarly have to file (there is no concept with gift tax returns of a single joint return for spouses).
Waiver: A spousal waiver may be signed with the beneficiary spouse (i.e., the spouse not gifting assts to the trust) waiving any claims or rights to the assets you transfer to the trust. If you have community property assets you should have an attorney prepare the appropriate legal documentation to transmute and break that community property characterization before either spouse transfers assets to their SLAT.
Local Counsel: If you set up your SLAT in one of the 19 states that permit self-settled trusts as suggested above, you might have counsel in each state in which each trust will be formed provide a legal opinion that the trust is valid in that jurisdiction.
Trust Company Review: Each institutional trust company will have to review the trust for any changes necessary to their assuming the position of trustee. You should just keep this and other steps in mind should you think you will wait to see how the election turns out before acting. All the steps when done right take time.
Searches: You might complete a lien and judgment search on yourself before giving assets to a SLAT as part of the due diligence before funding the trust. The performance of this due diligence may help identify any issues that may suggest transfers to the trust should not be made. If none are identified these steps should help deflect a later challenge by a claimant or the IRS based on a fraudulent conveyance, retained interest and other theories.
Solvency Affidavit: Consider signing an affidavit confirming that you have no known claims (list any that you are aware of), will be solvent after the transfers to the trust, etc. This, we believe, is important to your corroborating that the transfers will not be a fraudulent conveyance.
Gift: You might prepare a “Declaration of Gift” for gifts made to the trust wherein you confirm that the transfers to the trust are intended to be characterized as gifts.
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