SLANTs- Spousal Lifetime Trusts

Take-Away: Creating a trust for spouse may continue to be a sound estate planning strategy after the One Big Beautiful Bill Act.  However, rather than create a SLAT, which is a grantor trust for income tax purposes, an alternate strategy might be to intentionally create a non-grantor trust for the donor’s spouse- a SLANT.

Background: A few months back I wondered if the strong interest in spousal lifetime access trusts (SLATs) would abate now that the One Big Beautiful Bill Act (OB3) made permanent (if you believe the use of that word when it comes to taxes) each individual’s applicable exemption amount of $15 million. No longer are spouses arguably motivated to use their large applicable exemption amount with lifetime gifts in trust for their spouse for fear of losing that exemption, since the OB3 fixed each individual’s applicable exemption amount at $15 million and subject to annual COLA adjustments upward. In short, the ‘use it or lose it’ fear that motivated funding many SLATs is gone (but probably not forever.) However, those spouses who have created SLATs, or intend to do so, will still have to deal with the tax implications of the SLAT being taxed as a grantor trust, even if the spouses later divorce, or the beneficiary-spouse dies. [IRC 677.]

SLANT Overview: A variation on the conventional SLAT is a spousal lifetime access non-grantor trust, or SLANT. A SLANT is an irrevocable trust that is intentionally structured to benefit the donor’s spouse yet avoid grantor trust income tax treatment. Like a SLAT, a SLANT removes contributed assets and future appreciation of those assets from the donor-spouse’s taxable estate when that donor makes an irrevocable and completed gift to the trust. In addition, the donor’s available generation skipping transfer tax exemption (also up to $15 million) can be applied to the donor-spouse’s transfer of property to the SLANT. The difference is that a SLANT is normally used for income tax planning, more so than transfer tax planning.

SLANT Structure: Unlike a SLAT, a SLANT avoids the grantor trust rules [IRC 671-IRC 677] so that the trust, not the trust settlor, is treated as the taxpayer for income tax reporting purposes. The SLANT is drafted to avoid the spousal attribution rules by having an adverse party [discussed below] make all decisions that affect the beneficiary-spouse’s beneficial interest in the trust.

Trust Pays Income Taxes, Not its Settlor: The SLANT structure removes the income tax burden from the donor-spouse and causes the SLANT to be liable for its own income tax liability. Often high-income donors who face high state income tax liability will intentionally create the SLANT in a jurisdiction like Florida or Texas with no state income tax.

SLANT Avoids Grantor Trust Complications: In addition to eliminating the donor-spouse’s responsibility to pay income taxes with a grantor trust, the donor to a SLANT can avoid the complications and complexity of ‘unwinding’ the grantor trust’s status at a later date. A case in point is when the trust owns S stock. Sometimes events can convert the trust into an ineligible S corporation shareholder, which then could trigger adverse tax consequences, like the loss of S corporation status. A SLANT can reduce the risk of inadvertently terminating the S corporation status for stock that is owned by the trust.

SLANT Mitigates IRC 643(f) Exposure: A SLANT can also avoid the IRS later asserting IRC 643(f) to collapse multiple trusts into a single trust when the trusts have substantially the same settlors and beneficiaries, when the principal purpose of the structure is tax avoidance. Collapsing multiple trusts into a single trust could jeopardize some important estate planning strategies, such as: (i) qualified small business stock (QSBS) basis ‘stacking’ using multiple trusts to exploit the gain exclusion under IRC 1202; (ii) multiplying the state and local tax (SALT) income tax deduction; or (iii) exploiting the qualified income tax (QBI) deduction under IRC 199A. While the IRS’ assertion of IRC 643(f) is highly fact specific, the non-grantor trust status of a SLANT strengthens the argument that each trust is a separate taxpayer with distinct economic consequences.

SLANT Avoids Attribution:  Understanding a SLANT starts with IRC 672. That Code section provides that any power or interest held by the donor’s spouse, i.e., the beneficiary-spouse, either at the time the trust was created or from the time that a beneficiary marries the donor (for an existing power or interest) during the period of time that such spouses are married, treats the donor as holding that same power or interest in the trust.

Adverse Party: IRC 672(a) defines an adverse party as anyone who has a substantial beneficial interest that would be adversely affected by the exercise, or non-exercise of a power which is possessed with respect to the trust. One way adverse party treatment is created is to clearly designate a non-related and non-subordinate individual as both a trust beneficiary and trustee, to create an adverse party with a meaningful economic interest, and to require that adverse person to have full control over distributions to the beneficiary-spouse.

Example: Harry creates a SLANT for his wife Sally. Distributions to Sally from the trust must be approved by their son Bruno, who is also a remainder beneficiary. Any discretionary distributions to Sally from the SLANT will arguably deplete Bruno’s interest in the SLANT after Sally’s death. Bruno possesses an adverse interest to his mother, Sally.

Professional Trustee: A professional trustee will not qualify as an adverse party because an adverse party must hold a beneficial interest that would be materially affected by the exercise of the relevant power.

Two Features: A SLANT thus requires two main features: (i) An adverse party must hold substantial discretionary authority; and (ii) all discretionary distributions must require the prior consent of an adverse party.

Avoiding Attribution: Because a SLANT is structured to benefit a spouse, the trust must therefore isolate the beneficiary-spouse’s beneficial interests from any rights and powers that would otherwise be imputed back to the donor-spouse. This attribution applies both to powers held by the beneficiary-spouse over the trust and to the beneficiary-spouse’s beneficial interests in the trust. Consequently, it is important that the trust instrument avoid granting the beneficiary-spouse any right or authority that could be imputed (back) to the donor-spouse. Many grantor trust provisions are implicated by spousal attribution.

Reversionary Interest: IRC 673 treats the donor as owner when the donor retains a reversionary interest in the trust that exceeds 5% at the trust’s inception. Accordingly, a SLANT cannot give to the beneficiary-spouse a comparable reversionary right.

Revocation: IRC 676 will cause grantor trust treatment if the donor or a non-adverse party can revoke the trust.

Power to Distribute: IRC 677(a) will cause grantor trust treatment if the donor or a non-adverse party possesses the power to distribute income to, or accumulate income for, the trust beneficiary. Consequently, an effective SLANT cannot permit distributions to the spouse without the important involvement, e.g., the consent,  of an adverse party.

Administrative Powers: IRC 675 will create grantor trust status when the donor, or any non-adverse party, including the donor’s spouse, holds some administrative provisions without clear safeguards. These troublesome administrative powers include: (i) the ability to engage in transactions without full consideration; (ii) the ability to borrow from the trust without adequate interest or security; and (iii) administrative discretion that is so broad that it confers indirect economic control over the trust.

Ability to Control Beneficial Enjoyment: IRC 647 governs the powers to control beneficial enjoyment. This is the provision that is most often implicated. If a non-adverse party as to the donor-spouse, can affect beneficial enjoyment, the IRS will treat the donor as holding the relevant power. Restated, if income or principal can be distributed in the discretion of a non-adverse party to the beneficiary-spouse without the involvement of an adverse party, grantor trust treatment will be the result.

Practice Pointer: Because the potential loss, i.e., the death, of an adverse party could cause the trust to lose its non-grantor status, it will be important when the trust instrument is drafted to include mechanisms to replace the individuals who were added to satisfy the adverse-party requirement.

Conclusion: SLATs may not be as an important an estate planning device now that each spouse has a permanent applicable exemption amount of $15 million along with the opportunity to claim portability of the deceased spouse’s unused applicable exemption amount. For those who are cynical when it comes to believing anything in the Tax Code is permanent, they may continue to be interested in a SLAT- if they are willing to deal with the fact that a SLAT is taxed as a grantor trust. For those interested in a SLAT but who wish to avoid the grantor trust income tax liability associated with the SLAT, they might consider the use of a SLANT.

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