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Estate Planning: A Strategy to Reduce Risk When Giving Away Substantial Wealth

Posted by Concannon Miller on Tue, Aug 4, 2020

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Estate Planning: A Strategy to Reduce Risk if You're Giving Away Substantial WealthThe Tax Cuts and Jobs Act substantially increased the gift and estate tax exemption. For 2020, the inflation-adjusted amounts are $11.58 million for individuals and $23.16 million for married couples filing jointly.

This creates a significant tax-saving opportunity for wealthy families. However, because the exemption amounts revert to their pre-TCJA level ($5 million and $10 million, adjusted for inflation) starting January 1, 2026, you can only give away substantial wealth gift-tax-free (either directly or in trust) for a limited time. However, there's a chance that Congress could change the rules or extend them.

What would happen if you took advantage of this opportunity now and later discovered you needed the money? That's where a spousal lifetime access trust can come in.

Maintain Access

A SLAT is an irrevocable trust that permits the trustee to make distributions to your spouse during his or her lifetime, as necessary. Typically, SLATs are designed to benefit your children or other heirs, while paying lifetime income to your spouse.

When you establish a SLAT, you can make completed gifts to the trust, removing those assets from your estate. But you continue to have indirect access to the trust by virtue of your spouse's status as a beneficiary. Usually, this is accomplished by appointing an independent trustee with full discretion to make distributions to your spouse.

READ MORE: Estate Planning: How to Save Taxes using the Generation-Skipping Transfer Tax

Do's and Don'ts

SLATs provide welcome flexibility in uncertain times, but they must be planned and drafted carefully to avoid potential pitfalls. For example, to ensure that the assets are removed from your estate, you shouldn't serve as trustee. It's possible to name your spouse as trustee. However, if you do, distributions from the trust generally will be limited to those necessary for his or her health, education, maintenance or support. The trust should also prohibit distributions that would satisfy your legal obligation of support to your spouse.

To avoid inclusion of trust assets in your spouse's estate, your gifts to the trust must be made with your separate property. This may require additional planning, especially if you live in a community property state. And after the trust is funded, it's critical to ensure that the trust assets aren't commingled with community property or marital assets.

Another thing to keep in mind: A SLAT's benefits depend on indirect access to the trust through your spouse. So your marriage must be strong for this strategy to work. There's also a risk that you'll lose the safety net provided by a SLAT if your spouse predeceases you. One way to hedge your bets is to set up two SLATs — one created by you with your spouse as a beneficiary and one created by your spouse with you as a beneficiary.

But keep in mind that this strategy has the potential to run afoul of the reciprocal trust doctrine. If the IRS concludes that the two trusts are interrelated and place you and your spouse in about the same economic position as if you had each created a trust for your own benefit, it may undo the arrangement. In other words, the IRS may treat each trust as if the grantor had named him- or herself as a life beneficiary. Such an outcome would erase the tax benefits you're seeking. In general, the trusts' terms should be varied so that they're not substantially the same.

READ MORE: Charitable Remainder Trust: A Great Option for a Lasting Gift, Tax Savings

Regarding Clawbacks

One potential pitfall you no longer need to worry about is clawbacks. Originally, there was a concern that when the gift and estate tax exemption reverted to its previous level in 2026, the IRS could attempt to impose estate taxes on the excess of any pre-2026 gifts over the post-2025 exemption amount.

The issue stemmed from the way estate taxes are calculated: First, prior taxable gifts are added back into your estate (at their date-of-gift values) and estate tax is computed on the total (based on the date-of-death exemption amount and tax rate). Next, the tax is reduced by any gift taxes previously paid. Fortunately, in November 2019, the IRS issued final regulations that avoid this outcome.

Meet Objectives

A SLAT can provide you with a safety net, but it must be designed carefully to ensure it achieves your tax objectives and avoids IRS scrutiny. In short, you should work with experienced tax and estate planning professionals.

Concannon Miller provides estate and trust planning services for business owners and other high-net-worth individuals. Read more about our estate and trust planning services here or contact Tammie Yearwood, CPA, at tyearwood@concannonmiller.com or 610-433-5501 for more information. 

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© 2020

Topics: Estate and Trust Services

Concannon Miller’s unique, holistic and intimate approach to financial health sets us apart from smaller CPA firms with more limited resources as well as mega firms where mid-sized clients struggle for attention. Contact us here to talk about improving your business.

This communication is designed to provide accurate and authoritative information in regard to the subject matter covered at the time it was published. However, the general information herein is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purposes of avoiding tax penalties.

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