Matching SLATs may invite IRS reciprocal-trust scrutiny

Spousal lifetime access trusts, or SLATs, let one spouse move assets out of a taxable estate while naming the other spouse as a beneficiary. The vehicle can reduce estate tax exposure for high-net-worth couples, but paired SLATs that closely mirror each other can draw IRS scrutiny under the reciprocal trust doctrine.

A SLAT is an irrevocable grantor trust. The donor spouse uses part of their lifetime gift and estate tax exemption to fund the trust. When the trust is a grantor trust, the donor remains responsible for income tax on trust earnings while the beneficiary spouse may receive distributions under the trust terms.

Tax advisers and estate lawyers caution that when both spouses create near-identical SLATs the IRS could treat the transfers as remaining for the donor’s benefit and deny estate tax relief. Kevin Matz, a partner at ArentFox Schiff, warned, “If they’re identical, you’re vulnerable to the IRS applying what’s known as the reciprocal trust doctrine.” Martin Shenkman, partner at Shenkman Tietz, proposed making the two trusts economically different, such as varying asset allocations or placing a life insurance policy in one trust, and added that “there’s no bright-line test” for how different the trusts must be.

Advisers note tax and asset choices matter. Joe Sicchitano, head of workplace personal investing at Principal Financial Group, pointed out that assets placed in a SLAT do not receive the usual step-up in basis at death, creating potential capital gains exposure if highly appreciated assets fund the trust. He added that properly structured SLATs can preserve generation-skipping tax exemptions for grandchildren or later generations.

Practical errors can defeat a plan. Common mistakes include drafting a trust and failing to transfer assets into it, and assuming estate tax portability removes the need to fund a SLAT. Divorce can complicate outcomes when no prenuptial agreement exists, and an ex-spouse may claim trust benefits, legal advisers note.

One advanced basis-planning technique involves giving an in-law a general power of appointment so trust assets could receive a step-up in basis on the in-law’s death. Shenkman described the potential benefit for clients with large built-in gains, while Matz cautioned that such a power can allow the in-law to appoint assets away or expose them to the in-law’s creditors.

SLATs remain a niche strategy typically used by very wealthy families and business owners. Attorneys must draft the trusts and advisers should coordinate with counsel to ensure trusts are funded and documented to show economic differences between paired SLATs.