By Andrew Bellm
Spousal Lifetime Access Trusts (SLATs) have become an increasingly popular estate planning tool, particularly among high-net-worth individuals. While SLATs offer significant tax and asset protection benefits, they are not without their drawbacks—particularly in the event of a divorce. For grantors, divorce can turn a once-beneficial estate planning strategy into a complex and problematic arrangement.
This article explores the key challenges a grantor may face with a SLAT in the context of divorce, focusing on loss of access, control issues, and adverse grantor trust consequences.
Overview of SLATs
A SLAT is an irrevocable trust created by one spouse (the grantor) for the benefit of the other spouse (the beneficiary spouse) and often for the benefit of descendants. Properly structured, the SLAT removes the assets from the grantor’s taxable estate, while still allowing indirect access to the trust funds via the beneficiary spouse during marriage.
The trust is typically designed as a grantor trust, meaning the grantor is treated as the owner for income tax purposes (and the grantor pays the income tax), even though the assets are outside the grantor’s estate for estate tax purposes.
Core Divorce-Related Issues for Grantors
1. Loss of Indirect Access to Trust Assets
One of the most immediate concerns upon divorce is that the grantor loses any indirect access to the trust assets. While the grantor cannot legally retain direct benefits from the SLAT (without risking estate tax inclusion), access through the beneficiary spouse can provide practical flexibility during the marriage. Divorce severs this access permanently, leaving the grantor with no means of benefit from the trust assets, even if circumstances change.
When establishing a SLAT, it is important that the grantor consider the assets transferred to the SLAT as a gift. Because divorce severs the grantor’s indirect access, the grantor should consider the assets in the SLAT as potentially unavailable, since circumstances such as death or divorce may not be predictable.
2. Inflexible Trust Design and Irrevocability
A key feature of SLATs is their irrevocability. After divorce, the grantor may wish to remove the ex-spouse as a beneficiary, but this is not typically permitted. Unless the trust was specifically drafted to exclude the spouse upon divorce, the ex-spouse may continue to benefit from trust distributions, which can be especially unpalatable in contentious separations.
Provisions such as automatic disqualification clauses that revoke a beneficiary’s interest upon divorce can mitigate this risk but must be included during drafting. Courts may be reluctant to allow later modifications, particularly if the trust is deemed to have vested rights in beneficiaries.
3. Continuing Grantor Trust Taxation
SLATs are often established under the grantor trust rules, where the grantor pays income tax on SLAT income. The grantor trust rules can be beneficial by allowing the grantor to reduce his or her estate by paying income tax while shielding the trust assets from income tax obligations.
A subtler but significant post-divorce risk lies in the continued treatment of the SLAT as a grantor trust for income tax purposes—even after the grantor and beneficiary spouse divorce. Divorce terminates the spousal relationship, potentially ending grantor trust status. That seems favorable on the surface, but the reality is nuanced.
- If grantor trust status ends, the trust becomes a separate taxpayer, triggering new tax obligations and possibly resulting in gain recognition on assets with embedded appreciation if certain transactions (like substitutions or sales) occur.
- If grantor trust status persists (e.g., due to other retained powers under IRC § 673–678), the grantor may remain liable for income tax on a trust benefiting an ex-spouse—without any direct or indirect benefit. This is particularly problematic when the trust produces significant income, and even more so when an ex-spouse is serving as trustee of the SLAT with the ability to control trust income.
The uncertainty and administrative burden of determining trust tax status post-divorce adds to the complexity and potential cost of maintaining the SLAT.
Planning Strategies to Mitigate Divorce Risks
Proactive planning at the time of trust formation is crucial to avoid these issues. Recommended strategies include:
- Include a divorce contingency clause: Language that removes a spouse as a beneficiary upon divorce helps avoid post-divorce access and control issues.
- Limit retained powers: Minimize retained administrative powers that could result in grantor trust status persisting after divorce.
- Consider third-party trustees: Minimize post-divorce control and grantor trust issues by having a third-party serve as trustee rather than a spouse.
- Consider trust protector provisions: A trust protector with the power to modify beneficiary classes or administrative terms may provide flexibility to address post-divorce issues.
Conclusion
SLATs offer powerful tax and asset protection benefits when carefully structured within a stable marital context. However, their irrevocable nature, potential income tax consequences, and loss of access in divorce can create significant hardship for grantors. Advisors should counsel clients thoroughly on the long-term risks and consider incorporating protective mechanisms to ensure the SLAT remains beneficial—even if the marriage does not.