Joshua Tree Enterprises

Sign Up for Newsletter

About this Entry

This page contains a single entry by Associate Editor - 2 published on October 23, 2012 5:03 PM.

IRS Posts Final Form 706 and Instructions for 2012 Decedents was the previous entry in this blog.

A Potpourri of Developments: Wandry Appeal Dismissed, Same-Sex Marriage Developments & 2013 Inflation Adjustments (Including $14,000 Annual Gift Tax Exclusion) is the next entry in this blog.

Find recent content on the main index or look in the archives to find all content.

Cashing in on 2012 Transfer Tax Exemptions Using Spousal Lifetime Access Trusts

Cashing in on 2012 Transfer Tax Exemptions Using Spousal Lifetime Access Trusts

Greenberg Traurig LLP

      Unless the law is changed, at the end of 2012, the favorable estate and generation-skipping transfer (GST) tax rates and the amounts sheltered from those taxes under the Tax Relief Act of 2010 will end and less favorable ones will be reinstated.  In 2012, the maximum Federal estate, gift and GST tax rates are capped at 35 percent.  The maximum shelters from estate, gift and GST tax are unified at $5,120,000.  On January 1, 2013, the maximum estate, gift and GST rates will revert to 55 percent.  The maximum estate and gift tax shelter will revert to $1,000,000, and the GST exemption will revert to $1,000,000 indexed for inflation.  This means that prior to 2012 year end, a couple can transfer up to $10,240,000 (assuming no prior taxable gifts were made) without incurring any gift tax.  If the same transfer is made on or after January 1, 2013, the same couple would be limited to transferring $2,000,000 tax free (assuming no prior taxable gifts were made), and would incur substantial tax liability on the balance.  In view of the potential increases in rates and reduction in shelters, clients should consider strategies to use their shelters during the remaining days of 2012 before up to $8,240,000 of transfer tax shelter potentially is lost forever.  

      Of course, the simplest strategy to maximize the use of the increased shelters would consist of making outright gifts to donees, free of trust, in 2012.  While such gifts are possible, they often are not the most efficient use of shelters and may unnecessarily expose the gift to the donee's creditors or spousal attack in the event of the donee's divorce.  Additionally, funds transferred in such a gift arrangement ultimately would be subject to estate tax as part of the donee's estate.

      Another such strategy would be to create one or more trusts for descendants or other intended beneficiaries.  If no prior gifts have been made, a couple could fund such a trust prior to year end 2012 with $10,240,000 without incurring any gift tax.  If GST exemption is applied to the trust, no estate, gift, or GST tax would ever be incurred so long as the property remains in trust.  This trust would be a so-called dynasty trust which would permit property to pass from one generation to the next with sufficient flexibility to permit the beneficiaries access to the funds while at the same time preserving the tax benefits for future generations.  

      For many donors, however, parting with up to $10,240,000 of assets is daunting at best.  Clients often fear that such funds may be needed in the future for their care and general well-being.  The Spousal Lifetime Access Trust ("SLAT") may provide such clients with a favorable gifting solution.  A SLAT is an irrevocable trust created during a client's lifetime for the benefit of the client's spouse and descendants.  The terms of a SLAT generally allow the trustee to make discretionary distributions to the donor's spouse and descendants.  

      In order to maximize the available transfer tax exemptions, ideally each spouse would 
create a SLAT funded with up to $5,120,000 for the benefit of the other spouse and descendants.  In order to achieve the intended transfer tax planning, the trusts must have different terms and must give the spouses different economic interests.  Each spouse may have access to the trust for his or her benefit, provided that the beneficiary spouse is not granted an enforceable right to receive distributions from the trust, and that the access is not identical or reciprocal to the other spouse's trust.  Also, it is best not to fund the trusts with the same assets and not to create the trusts at the same time.  Given these "best practices", planning should be undertaken as soon as possible.

      Failure to differentiate the SLATs sufficiently could result in the IRS attempting to unwind the transfers.  In essence, the IRS could assert that because the SLATs were created at approximately the same time, using similar or identical assets and naming similar beneficiaries, the transfers should be disregarded for tax purposes and uncrossed (i.e., the trust for the beneficiary spouse is included in the beneficiary spouse's estate upon the beneficiary spouse's death) FN1.  In such a case, the IRS could contend that the donor spouse has been left in "approximately the same economic position as if he or she had simply named himself or herself life beneficiaries of his or her own trust," and, as a result, seek to unwind the transfer FN2.  This is commonly referred to as the "Reciprocal Trust Doctrine". 

      The most conservative approach to planning with SLATs would be to have one spouse create a SLAT for the benefit of his or her spouse and descendants and the other spouse create a dynasty trust for the benefit of his or her descendants only.  This should preclude any assertion of the Reciprocal Trust Doctrine.  

      More often than not, however, each spouse would prefer to have access to the other spouse's trust.  This may be accomplished without running afoul of the Reciprocal Trust Doctrine by varying the terms of the trusts.  In Levy v. Commissioner, T.C. Memo 1983-453 (1983), the Tax Court held that including a special power of appointment in one spouse's trust but not the other spouse's trust was a sufficient variation in the terms of the SLATs so as not to render them reciprocal.  Donor spouses should consider varying other trust terms as well, such as trustee appointments and distribution standards.  Additionally, SLATs could be formed in a self-settled trust jurisdiction (such as Alaska).  By doing such, if the SLATs are unwound, an argument may be made that the gifts to the SLATs are still complete because the SLATs' assets are insulated from the creditor claims of the beneficiary spouse who, under the Reciprocal Trust Doctrine, would be considered the donor spouse of the SLAT created for his or her benefit.  

      As a final measure, donor spouses should consider including provisions in the SLATs for backup marital deduction trusts.  As a result, any estate taxes imposed would be deferred until the second spouse's death.  The SLATs would include terms that provide if upon the first spouse's death the assets of either of the SLATs are includible in the estate of the first spouse, such assets would be held in a marital deduction trust for the benefit of the surviving spouse.  This would prevent the IRS from receiving an immediate financial windfall in the form of estate taxes by unwinding the SLATs.  

      Properly drafted SLATs are also advantageous because they can terminate upon the happening of an act of independent significance, such as divorce, bankruptcy, insolvency or death of the beneficiary spouse.  This can provide the donor spouse with some comfort in such an event.  In addition, SLATs can be drafted as intentionally defective grantor trusts to shift the income tax burden to the donor spouse as opposed to the SLAT bearing its own income tax liability.  The donor spouse's payments of income taxes on behalf of the SLAT would not constitute additional gifts.  This can have the effect of further leveraging gains inside the SLAT by allowing the trust assets to grow income tax free FN3, FN4.

      As the 2012 year end fast approaches, individuals with substantial resources should consider transferring wealth to maximize the inflated transfer tax credits which will soon expire.  Carefully drafted SLATs offer a great mechanism to capitalize on the current large transfer tax shelters while permitting each spouse to have access to the other spouse's trust for his or her benefit.

Parker F. Taylor and Jason A. Lederman are attorneys at Greenberg Traurig who practice in the areas of trusts and estates, and taxation.


1 See G. Slade, "The Evolution of the Reciprocal Trust Doctrine Since Grace and Its Current Application in Estate Planning," 17 Tax Mgmt Est. Gifts & Tr. Jl. (1992).

2 See US v. Estate of Grace, 89 S.Ct. 1730 (1969).

3 Rev. Rul. 2004-64, 2004-2 C.B. 7.

4 See Gans, Blattmachr & Zeydel, Supercharged Credit Shelter Trust, 21 Probate and Property 4, July-August 2007