Spousal Lifetime Access Trusts

Take-Away: The Michigan Probate and Estate Planning Council is currently looking at an amendment to the Michigan Trust Code that would address the legal consequences of a trust beneficiary who exercises a power of appointment to include the trust settlor as a potential beneficiary of the trust that he/she created. This change, if adopted, would arguably promote the use of a spousal lifetime access trust, or SLAT.

Background: This topic has been briefly covered in the past. It’s genesis is that many married individuals may be interested in adopting a SLAT while the federal gift tax exemption has been expanded after the 2017 Tax Act. The benefit would be to, gift-tax-free, fund an irrevocable trust for a spouse’s lifetime benefit, thus removing the transferred assets and their appreciation from future federal estate taxation. But the income from the transferred assets would still be available to the settlor, albeit indirectly, from the trust, since the settlor’s spouse is the lifetime beneficiary of the SLAT.

Problem: The perceived problem is when the beneficiary-spouse dies. At that time presumably the settlor no longer has indirect access to the SLAT’s income, as his/her spouse has died and is no longe a trust beneficiary.

Potential Solution: One proposed solution to the settlor’s loss of access to trust income problem is that the beneficiary-spouse could be given a testamentary limited power of appointment over the SLAT, so that the power of appointment could be exercised on the beneficiary-spouse’s death to name the settlor-spouse as a beneficiary of the SLAT that he/she previously created.

Concern: The concern associated with the beneficiary-spouse exercising a testamentary limited power of appointment is that the IRS could claim that the ‘relation-back’ doctrine applies, meaning that if the power of appointment was exercised to add the settlor back as a trustee, the SLAT would be treated as a self-settled trust, thus exposing the SLAT’s assets to the settlor’s creditor claims and also trigger estate inclusion for federal estate taxation on the SLAT settlor’s death under IRC 2036.

QTIP: The Michigan Trust Code currently contains a provision that indicates that when a QTIP trust is created for a spouse, if the settlor-spouse survives the beneficiary-spouse, the settlor can name him/herself as a continuing income beneficiary of the QTIP trust after the spouse’s death, and NOT be treated as the settlor of the QTIP trust for creditor access purposes, thus sheltering the continuing-QTIP trust assets from the settlor’s creditors, and also to remove the QTIP assets from the settlor-beneficiary’s taxable estate for federal estate tax purposes.

Proposed Amendment: The proposed legislation being studied by the Probate Council would extend this same type of treatment to a SLAT where the beneficiary-spouse names the settlor as a trust beneficiary by exercising the testamentary limited power of appointment. If enacted, that would permit the settlor-spouse to continue to have access to the income generated by the SLAT’s  assets for the balance of the settlor’s lifetime, comparable to the continuing QTIP trust treatment under the current law in Michigan.

Context: SLATs are important for a couple of reasons, not the least of which is protecting SLAT assets from creditor claims of both spouses. There is now some growing concern that with a new Congress, the 2017 Tax Act’s ‘doubling’ of the federal gift and estate tax exemption amount might be short lived, where we would, like back in 2012, see the potential for a dramatic drop in the amount of the federal gift exemption from $11.4 million to about $5.5 milllion on December 31 of a specific year. Thus, there could be a lot more interest in spouses creating and funding SLATs and using their currently large gift tax exemptions before a much earlier ‘sunset’ on the exemption is implemented by a new Congress and President.

Fewer marital couples will be willing to utilize their full federal gift tax exemption funding SLATs if they think that they will not have access to the SLAT’s income if their spouse dies. That is why the Council is exploring an amendment to the Michigan Trust Code that would legally authorize the beneficiary-spouse holding a testamentary power of appointment which could be exercised to ‘add’ the settlor spouse as a beneficiary to the SLAT that he/she created, without creating creditor problems or exposing those SLAT assets to estate taxation on the settlor-spouse’s subsequent death.

Conclusion: There is some concern that the expanded federal estate and gift tax exemptions may be short-lived. If that is the case, many married couples will take a serious look at adopting SLATs. If there exists the possibility that the settlor-spouse can continue to have access to the SLAT’s income, even after the beneficiary-spouse’s death, perhaps more married couples will adopt a SLAT before 2020. Hence the look at amending the Michigan Trust Code to provide that if a trust beneficiary exercises a testamentary limited power of appointment to add the settlor as a potential trust beneficiary, the settlor will not be treated as creating a self-settled trust for his/her own benefit.