The SLAT Series, Part VI: Withdrawal Rights

Examining a dangerous coalescence of tax planning issues

This is a continuation of the series on everything you ever wanted to know about estate planning trusts. For an intro and index to this series, please click here. The linked article will have a series index that gets updated periodically as well, so please bookmark it.

Table of Contents

1. Introduction

2. Crummey Withdrawal Rights

3. Five-by-Five Powers

4. Income Tax

5. Key Practice Pointers

Introduction

At a dinner at Heckerling this year, I was quite amused to hear a story of how an attorney (not present at the dinner, but being gossiped about nonetheless) claimed two SLATs weren’t reciprocal because the execution copies were printed in different fonts. All joking aside, practitioners use a variety of (often seemingly small) tweaks to distinguish SLATs created by each spouse. But, sometimes these features have unintentional inclusion or effects. Many SLAT forms are built on the chassis of the ILIT, which has certain features that are not always optimal for one-time gifts to a SLAT for reasons previously discussed. SLAT forms also sometimes integrate aspects of credit shelter trusts and various structuring options relating thereto in the quest to avoid the ever-looming threat of the reciprocal trust doctrine.

One option for SLATs that is often overlooked, or overused, is the withdrawal right. As alluded to in prior articles, withdrawal rights come in different flavors and have different outcomes. On one hand, we have Crummey withdrawal rights which are designed to create a gift tax annual exclusion to the donor for a one-time transfer (even if that one-time transfer is repeated on an annual basis). On the other hand, we have recurring annual withdrawal rights in the form of what are known as five-by-five powers. The articles linked above (and other articles further linked in such articles) discuss the broader gift, estate, and GST tax effects of these withdrawal rights.

But, when drafting SLATs, special attention needs to be given to the inclusion of withdrawal rights themselves. Besides the tax effects, these rights can have broader implications. For example, depending on the state, withdrawal rights could jeopardize some of the creditor protection of the SLAT. These creditor protection issues can be further eroded if the reciprocal trust doctrine is applied, either for transfer tax purposes or even just for state-law creditor protection. And, asset mix matters. Withdrawal rights may not be appropriate for some assets, especially those that are illiquid, and they can quickly frustrate the planning goals of the SLAT for a beneficiary who goes rogue.

This article briefly explores some of these issues from a tax perspective, while teeing up a broader discussion to follow on the non-tax risks of withdrawal rights.

Crummey Withdrawal Rights

Spousal and non-spousal Crummey powers are not built alike. Or, at least, they shouldn’t be. Yet, I have been able to count on a third certainty over the last several years (beyond just death and taxes). That certainty is that I will review a gift tax return (in an independent capacity) that claims a full annual exclusion for a spousal Crummey withdrawal right.

Why is this an issue?