Posted On: OCTOBER 2023
January 1, 2026, is a significant date for estate planning. On that day, the federal gift and estate tax exemption amount set by the Tax Cuts and Jobs Act will sunset. Currently, the inflation-adjusted exemption stands at $12.92 million ($25.84 million for married couples). But in 2026, it’s scheduled to drop to only $5 million ($10 million for married couples). Based on current estimates, those figures are expected to be adjusted for inflation to $6.08 million and $12.16 million, respectively.
If your estate exceeds, or is expected to exceed, 2026 exemption levels, consider implementing planning techniques today that can help you reduce or avoid gift and estate tax down the road. For example, an individual with an $8 million estate could avoid roughly $800,000 in federal estate tax by transferring assets to his or her heirs before the exemption is reduced.
However, what if you’re not currently ready to give significant amounts of wealth to the next generation? Perhaps you want to hold on to your assets in case your circumstances change in the future. Fortunately, there are techniques you can use to take advantage of the current exemption amount while retaining some flexibility to access your wealth should a need arise. Here are four of them.
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.
If the trust is designed and administered properly, the assets will be excluded from your estate and 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.
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. If you employ this strategy, be sure to plan the arrangement carefully to avoid running afoul of the “reciprocal trust doctrine.” (See “Watch out for reciprocal trusts” below.)
A special power of appointment trust (SPAT) is an irrevocable trust in which you grant a special power of appointment to a spouse or trusted friend. This person has the power to direct the trustee to make distributions to you.
Not only are the trust assets removed from your estate (and shielded from gift taxes by the current exemption), but so long as you are neither a trustee nor a beneficiary, the assets will enjoy protection against creditors’ claims.
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.
One way to reduce this risk is to create a “hybrid DAPT.” This strategy involves setting up a trust where you’re not initially named as a beneficiary, thereby assuring protection from your creditors. However, if you need access to the assets in the future, a trusted person (such as a trust protector) has the power to add you as a beneficiary, converting the trust into a DAPT.
A qualified personal residence trust (QPRT) allows you to transfer your home to a trust for the benefit of your children or other loved ones, while retaining the right to live in the home during the trust term. At the end of the term, title to the home is transferred to your beneficiaries, but you can arrange to continue living there in exchange for fair market rent.
Keep in mind that for this technique to work, you must survive the trust term. Otherwise, the home’s value will be included in your taxable estate.
The best of both worlds
The techniques described above are just a few examples of strategies you can use to enjoy the best of both worlds: Taking full advantage of the current exemption amount before it expires, without giving up access to your hard-earned wealth.
Bear in mind that Congress may act before the sunset date of January 1, 2026. Indeed, it may vote on legislation to make certain provisions of the Tax Cuts and Jobs Act permanent.
Sidebar: Watch out for reciprocal trusts
Couples who establish spousal lifetime access trusts (SLATs) for each other must plan carefully to avoid 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..