The SLAT Series, Part III: Issues with Grantor Trust Status

Understanding some grantor trust risks of SLATs, and recent developments relating thereto

This is the third installment of a comprehensive overview of spousal lifetime access trusts, or SLATs. For a series index and the first article in this series, click here. To skip to the intro, click here.

For the prior article in this series, click here.

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Table of Contents

1. Intro

2. First Development - CCA 202352018

3. Second Development - Revenue Ruling 2023-2

4. Third Development - Repeal of Code Section 682

5. Conclusion and Summary

Intro

In the introductory article to this series, we walked through the estate tax credit mechanisms and proposed regulations that affect spousal lifetime access trusts, or SLATs. And, in the last article, I highlighted the ways in which a SLAT is often treated as a grantor trust.

To summarize what we have discussed so far, the sunset of the TCJA (if it indeed occurs) will take away one-half of the inflation-adjusted basic exclusion amount. But, if a planning goal is to use this portion of the exclusion before it is lost, the current estate tax exclusion anti-clawback regulations operate in a way that prevents lifetime gifts from moving the needle unless they use more than the one-half of the exclusion that might go away.

This requires a significant gift of capital during life, along with loss of access to that capital if you want to freeze the estate tax value of the gift. After the anti-clawback regulations came out in 2020, some practitioners theorized that the value freezing goal (discussed in the last article) could be abandoned in favor of a grantor-retained trust that used estate tax exclusion while intentionally creating estate inclusion under Code Section 2036. Other practitioners theorized that this type of arrangement could be abusive, and a new set of proposed (but not yet finalized) anti-clawback regulations confirmed that this arrangement could, indeed, be abusive for lifetime completed gifts that were more “testamentary” in nature.

What if, however, a grantor could gift to a trust in which the grantor’s spouse, and not the grantor, “retains” an interest in gifted property? As noted in the last article, so long as the grantor funds the trust with their own separate property (a subject for later in this series), the beneficial interest of the grantor’s spouse should not cause any issues under Code Section 2036. Further, the potential of the grantor to indirectly and incidentally “share” in the grantor spouse’s interest by virtue of the marital relationship may not cause any issues under Code Section 2036. By avoiding 2036, the SLAT can also avoid the proposed anti-clawback regulations that would otherwise ignore lifetime use of basic exclusion amount.

This seems, on the surface, to create a compelling case for SLATs. But, to fully balance the benefits and risks of a SLAT, one must be familiar with the income tax risks inherent in the grantor trust status of SLATs. As I noted in the last article, the substantial majority of SLATs are taxed as wholly-grantor trusts due to the spouse’s retained interest in current or accumulated trust income under Code Section 677(a)(2), and possibly due to a trustee’s retained discretion to use trust income to pay premiums of life insurance on the grantor’s life under Code Section 677(a)(3). This income tax treatment and the associated risks are exacerbated by three recent developments in reverse order of chronology.

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First Development - CCA 202352018