Spousal Lifetime Access Trusts (SLATs) and non-grantor trusts are two popular types of irrevocable trusts. How do you know which one is right for you? This article explains what these trusts are and when they make sense.

Key Highlights and Takeaways

• Two Powerful Estate Tax Strategies: SLATs and non-grantor trusts both save estate tax, but they’re used in different circumstances.
• SLATs are Tax-Efficient Trusts for the Grantor’s Spouse: SLATs are very estate-tax efficient and make a lot of sense for people who want to transfer wealth to future generations. What distinguishes SLATs from other irrevocable grantor trusts is that they name the grantor’s spouse as a primary beneficiary.
• Non-Grantor Trusts Avoid Both State Income Tax and Estate Tax: A non-grantor trust can be a valuable tool for taxpayers in high-tax states who are looking to transfer wealth to future generations, as non-grantor trusts can avoid not only future estate tax but also state income tax.

What is a SLAT

A SLAT is a particular type of intentionally defective grantor trust (IDGT), and has much in common with other IDGTs. A person (the “grantor”) creates a SLAT and names the grantor’s spouse as either the sole initial beneficiary or one of the initial beneficiaries. Typically upon the sooner of the spouse’s death or divorce, the remaining trust principal is split into separate trusts for the grantor’s descendants. The grantor funds the trust using a portion of his or her lifetime gift and estate tax exemption. Once an asset is in the trust, that asset is outside the grantor’s estate and will never be subject to gift tax, estate tax, or generation-skipping transfer tax as long as it remains in the trust. Any resulting appreciation will also be outside the grantor’s estate. Yet, because the grantor’s spouse is a beneficiary, the grantor’s spouse can receive distributions. This can give the grantor “backdoor access” to the trust principal (though distributing SLAT principal to the grantor’s spouse is generally not very tax efficient). Because a SLAT is a “grantor trust,” the grantor has the option to pay the trust’s taxes, which is a way to transfer additional wealth to the trust. This makes SLATs even more estate-tax efficient than they would otherwise be. (You can learn more about SLATs here.)

SLAT Example

Imagine that Ellen is a New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Ellen sets up a SLAT for the benefit of her spouse and then contributes a $6 million asset to it, she will use up $6 million of her lifetime gift tax exemption, but the asset will be able to grow outside of her taxable estate. Ellen will also be able to pay the trust’s income taxes, allowing the trust to generate 9% annual post-tax returns and shifting more wealth out of Ellen’s taxable estate. After 25 years, the SLAT’s assets will be worth about $51.7 million! And if Ellen dies in Year 25, she will have saved her heirs about $20.4 million of tax relative to the counterfactual where she hadn’t funded the SLAT.

Benefits of SLATs

1. Estate Tax Savings: The primary advantage of a SLAT is its ability to use a grantor’s lifetime gift tax exemption to efficiently shift assets out of the grantor’s estate for estate-tax purposes. The grantor can pay the income tax on the trust’s income, effectively shifting even more wealth into the trust and out of the grantor’s estate. Finally, the grantor can lend to the trust free of any tax consequences — loans are another powerful tool that taxpayers use to shift wealth out of their estates.
2. Asset Protection: A SLAT, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, SLATs can help shield inherited assets from a divorcing spouse.
3. Potential Income-Tax Savings: Although SLATs don’t provide any immediate income-tax savings, they can indirectly save income tax down the line. For example, if the grantor names both the grantor’s spouse and the grantor’s child as beneficiaries, the trustee can distribute an appreciated asset to the grantor’s child, who may be in a lower tax bracket. The distribution itself will have no tax consequences, but when the grantor’s child later sells the asset, he or she will pay less tax than the grantor would have paid, due to that lower tax bracket.
4. Liquidity and Indirect Access: Compared to many other tax strategies, SLATs have little impact on a grantor’s liquidity. Though the grantor will have transferred some portion of his or her assets to the trust, the grantor can borrow from the SLAT without any tax consequences. Moreover, the grantor’s spouse can receive distributions from the SLAT if necessary.
5. Ideal for Illiquid Assets: Unlike GRATs, SLATs work well whether funded with liquid or illiquid assets.
6. GST Efficiency: A person can allocate generation-skipping transfer (”GST”) tax exemption to a SLAT when the trust is first funded. As a result, the SLAT is a popular form of dynasty trust.

Drawbacks of SLATs

1. No State Income Tax Savings: Unlike non-grantor trusts, SLATs don’t save state income tax.
2. Grantor Trust Status Locked in: With grantor trusts where the spouse is not a beneficiary, the grantor can always turn off grantor trust status and, by doing so, transform the trust into a non-grantor trust. However, as long as the grantor’s spouse is a beneficiary of a SLAT, this isn’t possible. While grantor trust status is generally desirable, there are situations where grantor trust status is inefficient. The ability to turn grantor trust status off is a valuable perk, one that SLATs can’t offer.
3. Separate Property: SLATs must be funded with the grantor’s sole and separate property — if a SLAT is funded with the spouse’s property, the SLAT will fail to avoid estate tax (at least in part). Since many couples own most of their property jointly or as community property, this can be a problem. Where it is a problem, both spouses must agree in advance of the SLAT being funded that the property that’s funding the SLAT is the grantor’s separate property. Understandably, sometimes married couples aren’t comfortable signing documents that transfer property from one spouse to another.
4. Irrevocability: When a grantor makes a gift to a SLAT, the gift is irrevocable (though the grantor can swap assets in and out of the trust at any time, as long as the swapped assets are exchanged for other assets with equal value).
5. No Direct Control: Typically the grantor does not act as trustee of the SLAT, though he or she can remove and replace the trustee at any time, lend money to or borrow money from the trust, get reimbursed by the trust for the trust’s tax liabilities (if the grantor doesn’t want to pay), and swap assets with the trust.

What is a Non-Grantor Trust?

A non-grantor trust is a type of irrevocable trust that is treated as a separate taxpayer for income-tax purposes. By setting one up in a no-tax state, taxpayers can avoid state income tax. Properly structured non-grantor trusts also help families avoid estate tax, since assets gifted to them (and any appreciation after the date of the gift) will be outside the grantor’s estate for estate-tax purposes.

Typically, a person (the “grantor”) creates a non-grantor for the benefit of one or more loved ones — such as children, grandchildren, or siblings. The grantor funds the trust using a portion of his or her lifetime gift and estate tax exemption. Once an asset is in the trust, that asset is outside the grantor’s estate and will never be subject to gift tax, estate tax, or generation-skipping transfer tax as long as it remains in the trust. Any resulting appreciation will also be outside the grantor’s estate. (You can learn more about non-grantor trusts here.)

Non-Grantor Trust Example

Imagine that Jim is a New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Jim sets up a non-grantor trust and then contributes a $6 million asset to it, he will use up $6 million of his lifetime gift tax exemption, but the asset will be able to grow outside of his taxable estate. After 25 years, the non-grantor trust’s assets will be worth about $33.5 million! And if Jim dies in Year 25, he will have saved his heirs about $15.2 million of tax between state capital gains taxes and estate taxes relative to the counterfactual where he hadn’t funded the non-grantor trust.

Benefits of Non-Grantor Trusts

1. Estate Tax Savings: Non-grantor trusts use a grantor’s lifetime gift tax exemption to efficiently shift assets out of the grantor’s estate for estate-tax purposes. However, non-grantor trusts are a bit less estate-tax efficient than IDGTs.
2. State Income Tax Savings. In California, the top marginal state income-tax rate is 13.3%. In New York City, the top rate is 14.776%. In South Dakota, the top marginal state income-tax rate is 0%. Setting up a non-grantor trust in a state like South Dakota, and then putting investments that generate lots of investment income inside of that trust, can save a grantor’s family a lot of income tax over time.
3. Asset Protection: A non-grantor trust, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, non-grantor trusts can help shield inherited assets from a divorcing spouse.
4. QSBS Stacking. For founders or early startup employees who have QSBS-eligible stock, perhaps the biggest benefit of non-grantor trusts is the additional QSBS exclusion they receive. Non-grantor trusts are eligible for their own $10 million QSBS exclusions — a single QSBS-stacking non-grantor trust can save a family millions of dollars of capital gains tax.
5. Various Federal Deductions. Non-grantor trusts get their own federal deductions and exemptions such as the $10,000 state and local income tax deduction, excess business loss deductions, mortgage interest tax deductions, Section 199A small business tax deductions, and more. Collectively, these tax benefits can be quite significant.
6. Ideal for Illiquid Assets: Non-grantor trusts work well whether funded with liquid or illiquid assets.
7. GST Efficiency: A person can allocate generation-skipping transfer (”GST”) tax exemption to a non-grantor trust when the trust is first funded. As a result, the non-grantor trust is a popular form of dynasty trust.

Drawbacks of Non-Grantor Trusts

1. Illiquidity: When the grantor makes a gift to a non-grantor trust, he or she loses access to the assets in the trust. Unlike with SLATs or some other trust types, with a non-grantor trust, the grantor cannot “swap” or borrow assets without income-tax consequences.
2. Irrevocability: When a grantor makes a gift to a non-grantor trust, the gift is irrevocable.
3. Spouse Cannot Be Beneficiary: Generally the grantor’s spouse cannot be the beneficiary of a non-grantor trust.
4. Potentially Higher Federal Tax Brackets: Non-grantor trusts are taxed at the highest federal tax bracket on annual income above a few thousand dollars. If the grantor is not a high-bracket taxpayer, gifting assets to a non-grantor trust may actually increase the effective federal tax rate paid on any income generated by assets inside the trust.
5. No Direct Control: The grantor cannot act as trustee of the non-grantor trust, though he or she can remove and replace the trustee at any time.

Should You Set Up a SLAT or a Non-Grantor Trust?

SLATs and non-grantor trusts both save estate tax. They can both be set up as dynasty trusts that can benefit not only a taxpayer’s children but also their grandchildren, great-grandchildren, and beyond. But there are crucial differences. SLATs are more estate-tax efficient. Non-grantor trusts can save state income tax, which is a big deal for people in high-tax states like New York or California.

You’ll often see people in high-tax states with $10 million to $25 million of assets setting up non-grantor trusts. These people tend to be more focused on state income tax than on estate tax. Non-grantor trusts are also desirable for people with QSBS stock, since they can claim their own $10 million QSBS exclusions.

SLATs are popular with people who either live in low-tax states or who expect to be significantly over the estate tax exemption amount, and therefore are more focused on estate tax than on state income tax. The ability to name a spouse as beneficiary also makes SLATs appealing to some people.

It is important to note that there are lots of other gift and estate tax strategies that may make more sense than a SLAT or a non-grantor trust, depending on circumstances. Those strategies are also worth exploring. Moreover, SLATs and non-grantor trusts are not mutually exclusive; some people set up both.

Conclusion

SLATs and non-grantor trusts are both powerful estate-tax strategies. Hopefully this article has given you a better idea of what each structure entails, and whether one or the other might be a better fit.

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