Take Advantage of the Historically High Estate and Gift Tax Exemptions
- May 17, 2023
- By: David Garcia CFP®, ADPA® CPA
With many current estate tax provisions due to expire in 2025, now is the time to proactively take advantage of historically high exemption amounts. No matter who wins the White House and Congress in 2024, rising federal deficits, unprecedented spending, and lower tax revenues could potentially mean higher taxes in the future. In such a scenario, the estate tax exemption could be an easy target for Congress since it mainly affects the very wealthy. For clients with large estates, a Spousal Lifetime Asset Trust (SLAT) can be an effective estate-planning tool. Current law allows individuals to give away up to $12.92 million ($25.84 million for married couples) without paying estate or gift taxes. This is a good way to transfer assets to the next generation, but it does mean giving up the use of the assets during your lifetime. Establishing a SLAT allows you to lock in the current estate exemption amount and grow assets outside of your taxable estate while still retaining the ability to access the assets. Below is a brief explanation of how a SLAT works.
Spouse 1 sets up an irrevocable trust for spouse two which would allow spouse 2 to receive income from the trust as well as principal distributions for health, education, support, and maintenance. The primary beneficiary of the trust is typically spouse 2 (and upon spouse 2’s passing, assets will normally continue in trust for the benefit of descendants). Spouse 2 can serve as trustee. The trust's grantor (spouse 1) makes a gift of assets to the trust and applies a portion of his or her exemption so that the transfer, while reportable on a 709 gift tax return, does not incur any gift tax.
The benefit of the trust is that you are able to remove assets from your taxable estate, including any growth in those assets, but still receive benefits indirectly through your spouse. An additional benefit for larger estates is that you are able to fully utilize your remaining exemption; if the exemptions are subsequently reduced, you are locked in at the higher exemption amount you utilized during your lifetime. The best assets to transfer to the trust would be those expected to have the highest growth rate.
The trust is structured as a grantor trust for income tax purposes, which means that the grantor pays the income tax on the trust, reducing the tax drag on the growth in trust assets. Additionally, the trust is normally set up as a generation-skipping trust which means that the assets can be held in trust for future generations with no estate tax incurred from generation to generation.
It is possible that the spouse of the grantor (spouse 2) may also set up a second trust for the first grantor (spouse 1), although it is extremely important that the two trusts be substantially different to avoid the reciprocal trust doctrine. This is a doctrine that the IRS may potentially impose so that it can ignore the trusts and treat the grantor as the owner of the assets at his or her death. This could unwind the benefits of both trusts.
Of course, SLATs have disadvantages that you should be aware of before establishing one. Some of these disadvantages are as follows:
- The trust is irrevocable and can't be changed;
- You need to make sure that separate assets are used to fund the trust and not joint assets;
- Upon the death of a spouse, the grantor will lose access to the funds of which the spouse was the beneficiary while alive. Individuals should consult their EKF advisor to perform the appropriate modeling to determine how much can comfortably be gifted to the trust.
- There is no step-up in the basis of assets at death because none of the assets are included in either taxable estate.
- A risk of the reciprocal trust doctrine being imposed if you establish two trusts.
The Tax Cuts and Jobs Act reduced the number of estates affected by the estate tax, but the law’s exemption is set to expire at the end of 2025. With Presidential and Congressional elections coming up in 2024, the possibility of significantly lower exemption amounts is real. Now is the time to start thinking about which estate tools provide your family the most flexibility for the long term, no matter what happens with the tax code. When used correctly, SLATs provide the opportunity to maximize tax-efficient wealth transfer and growth. Your EKF advisor is happy to discuss the benefits and disadvantages of SLATs to determine if this estate strategy is right for you.¹
