In a previous blog, I discussed taking advantage of the 2012 $5.12 million applicable exclusion now, before it goes down to $1 million on January 1st. As I mentioned in that blog, one way to use the exclusion is through the use of a trust for the benefit of the spouse which does not qualify for a marital deduction and is not included in the spouse’s estate. The American Academy of Estate Planning Attorneys has such a trust, named the Family and Spouse Gifting Trust. It is also known more widely by the name Spouse and Family Exempt Trust, hence the SAFE acronym. Today, I’ll focus on two traps in implementing such trusts.
First, if the two spouses are setting up such trusts for each other, the “reciprocal trust doctrine” could apply to unwind the transaction. What this means is that it would make it as though the husband and wife were setting up trusts for themselves, instead of each other. In that case, the trusts would be included in their estates (under Section 2036) and the planning would have been for naught. Unfortunately, there is no absolute way to avoid this issue, but making them as different as possible will help. Varying the following can help: the trustees, the dates of creation, and the inclusion of limited powers of appointment. However, perhaps the safest way to ensure the non-reciprocal nature of the trusts is to not have both spouses as beneficiaries of each other’s trusts. This can be achieved by having the husband set up a trust for the benefit of his wife and children, while the wife sets up a trust for just the kids’ benefit. In the trust set up by the wife, the husband can become a beneficiary of the trust upon the wife’s death or divorce.
The second trap to consider is the “step transaction doctrine” in which the steps of a transaction are collapsed. This could be a problem where one spouse gifts assets to the other spouse, who then uses the assets to set up a trust for the benefit of the donor spouse. If you collapse the steps, the donor spouse is setting up a trust for himself or herself, resulting in inclusion (under Section 2036). The best way to side-step the step transaction doctrine is to put as much time as possible between the different steps. For example, if wife is giving property to husband, significant time should elapse between the date of the original inter-spousal gift and the date the husband sets up the trust for wife. Also, the amount of the gift from wife to husband in the example could be different (either more or less) than the amount which husband gives to the trust for wife’s benefit.
When you avoid the traps, the SAFE Trust is a great way for clients to utilize their applicable exclusion, especially this year. But, time is running out, because it takes time to safely navigate these traps, get appraisals, and complete the planning before year-end.
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
- The Magic of Grantor Trusts - September 19, 2023
- IRS Confirms Grantor Trust Status Alone Does Not Cause a Step-Up in Basis - August 15, 2023
- Double Your Gifting with Spousal Gift-Splitting - January 11, 2022