The year 2017, when the Tax Cuts and Jobs Act was signed into law, seems like a long time ago. As you may be aware, many of the tax provisions of that law are set to expire in a relatively short amount of time — on January 1, 2026.
For estate planning, it’s important to realize that the federal gift and estate tax exemption is scheduled to drop to an inflation-adjusted amount of only $5 million. (Based on current estimates, the amount is expected to adjust to approximately $6.08 million). Still, that’s a far cry from today’s amount of $13.61 million.
While there’s a chance that Congress will step in with new tax law legislation before 2026, there’s no guarantee. Thus, you need to consider strategies that take advantage of the current exemption amount while retaining flexibility to access your wealth should a need arise.
Draft a SLAT
If you’re married, a spousal lifetime access trust (SLAT) can be an effective tool for removing wealth from your estate while retaining access to it. A SLAT is an irrevocable trust, established for the benefit of your children or other heirs, which permits the trustee to make distributions to your spouse if needed, indirectly benefiting you as well.
So long as you don’t serve as trustee, the assets will be excluded from your estate and, if the trust is designed properly, from your spouse’s estate as well. For this technique to work, you must fund the trust with your separate property, not marital or community property. However, there’s a caveat.
Beware the “reciprocal trust doctrine”
Keep in mind that if your spouse dies, you’ll lose the safety net provided by a SLAT. To reduce that risk, many couples create two SLATs and name each other as beneficiaries. Couples who establish such trusts for each other must plan carefully to avoid running afoul of the “reciprocal trust doctrine.”
Under the doctrine, the IRS may argue that the two trusts are interrelated and leave the spouses in essentially the same economic position they would’ve been in had they named themselves as life beneficiary of their own trusts. If that’s the case, the arrangement may be unwound and the tax benefits erased.
To avoid this outcome, the trusts’ terms should be varied so that they’re not substantially identical. For example, you might appoint different trustees, establish the trusts in different states, fund the trusts at different times, designate different beneficiaries, or provide for different withdrawal rights or powers of appointment.
Take advantage of the gift tax exemption
A domestic asset protection trust (DAPT) is another tool that allows you to remove wealth from your estate, taking advantage of the current gift tax exemption, while preserving indirect access to your assets in the future. A DAPT is an irrevocable trust established in a state with a DAPT law, which protects trust assets from creditors even though you’re a beneficiary of the trust. An independent trustee has the power to make discretionary distributions to you should a need arise.
DAPTs aren’t risk-free, however. Their ability to shield assets from creditors hasn’t been fully tested in the courts, particularly for trusts established in a state with a DAPT law by a resident of a non-DAPT state.
Uncertainty reigns
Having so much uncertainty regarding estate tax laws can be unnerving. Plus, the outcome of the national elections in November may have a major effect on any new tax legislation in 2025. Your advisor can keep you apprised of new tax laws that can affect your estate plan.
