Divorce, death and taxes: 3 risks connected with SLATs

Spousal lifetime access trusts, or SLATs, have been an estate planning tool for many years, but the irrevocable trusts have gained popularity ahead of the pending sunset of current estate and gift tax exemption laws. On Jan. 1, 2026, the $12.92 million gift and estate tax exemption per individual will revert to the prior law's $5 million exemption cap (adjusted for inflation). 

That is a big gap to manage through gifting and estate planning strategies. 

AMYPETRESKY

In a SLAT, one spouse makes a gift to benefit the other spouse — and potentially other family members — removing the assets from their combined estates for tax purposes. But while useful instruments, SLATs are not foolproof. The three big risks associated with SLATs are: divorce, the premature death of a beneficiary spouse and ongoing tax compliance.

Divorce
Divorce presents a tricky situation for assets in general, but the non-donor spouse in a SLAT risks losing access to assets if the donor spouse opts not to provide it. In addition, the divorced donor spouse may end up paying taxes on assets only available to the ex-spouse. While it may be possible to renegotiate the terms of a SLAT as part of a divorce settlement, there are obvious complications when adding divorce attorneys to the mix of estate planning attorneys and CPAs. It may be impossible to regain access depending on the complexity or nastiness of the divorce. 

Death
Another access risk is the unexpected or premature death of the beneficiary spouse. Although SLATs can be structured to return assets to the donor spouse in the event of the beneficiary's death, the surviving spouse has essentially wasted the exemption because returned assets will be added back into the donor spouse's estate and, if valued beyond the non-taxable exemption, will be taxed at a much higher rate. After the death of the beneficiary spouse, assets may be accessible to the surviving spouse through the kindness of secondary beneficiaries, but distributions to the surviving spouse potentially would become income on that surviving spouse's tax return.  

If a couple has more than one SLAT, provisions are often differentiated to comply with reciprocal trust doctrines, and this differentiated language may end up causing one spouse to have less access to assets than the other spouse. These economic implications should be modeled as "what-if" scenarios before setting up multiple SLATs.

Taxes and more taxes
Although SLATs are designed to reduce the size of an individual's taxable estate while still providing indirect access to assets through spouses or family members, there are pitfalls to their administration and tax treatment. SLATs can work perfectly well with the assistance of knowledgeable estate attorneys and CPAs, helping the client follow terms and tax filing requirements to the letter. But there are also many ways to ruin a SLAT if not managed consistently as part of gifting, tax planning and administration. Mismanagement leads to taxation and penalties. 

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First, a timely gift tax return must be filed after funding a SLAT. Also, the donor will need to decide if the assets in the SLAT will be used within the beneficiary's lifetime or if assets are intended to pass to the next generation. The CPA filing the gift tax return may need to allocate a generation-skipping tax. Failure to file a timely gift tax return can result in accrued interest, penalties or even the asset never officially being removed from the donor's estate.

Because SLATs are typically set up as a grantor trust for income tax purposes, the grantor also pays the income tax on behalf of the trust. Quite often, the mechanics to report this income are  overlooked. A grantor trust with income will require the setup of a taxpayer identification number. 

Plus, the U.S. tax code imposes an income filing requirement on trusts with taxable income of $600 or more. This is an annual income test for the assets held in trust, therefore grantors must be aware of how much interest income, dividends or capital gains have been earned in the SLAT, and on a timely basis share this information with their CPA. The CPA must properly calculate any annual tax obligation and necessary payments.

If certain assets held in trust are sold, there are also income tax obligations for the donor spouse. For example, if the donor spouse places the couple's appreciating vacation home in trust and the couple decides to sell the asset in the future, the donor spouse will incur income taxes on the home's increased value when sold. Selling assets in the trust with capital gains triggers capital gains tax for the donor spouse. This means that individuals must be careful about the types of assets placed in the SLAT and whether their increase in value will result in additional taxation.  

While SLATs can be beneficial when it comes to estate and tax planning, they can also be expensive and complex. Clients, their financial planners and other advisors should be on the same page regarding trust provisions for access, the method and timing of distributions and future tax implications.