Jim Dougherty, a parter at Dungey Dougherty PLLC, is speaking at two sessions of the Heckerling Institute on Estate Planning this week, discussing ethical, practical and tax planning with spousal lifetime access trust for married and divorced couples. Wealth Management and Trusts & Estates interviewed him about his topic.
Ethical Dilemmas
Wealth Management: What are the key ethical dilemmas estate planners face when establishing SLATs, particularly when representing both spouses? How do you navigate potential conflicts of interest, and when should separate counsel be recommended to ensure each spouse’s interests are properly protected?
Jim Dougherty: SLATs aren’t typically the first estate-planning documents an attorney would assist a couple with. Typically, an engagement would begin with the creation or a review of foundation estate-planning documents (such as a last will, revocable trust and documents to enable decisions to be made in the event of incapacity). However, attorneys have ongoing ethical duties related to potential conflicts. Just because there wasn’t a conflict for one task for spouses doesn’t mean conflict can’t arise when doing another. Given the irrevocable nature of SLATs, there could be a conflict that wasn’t present when drafting foundational estate-planning documents. Differences in planning objectives or the impact the creation of a SLAT would have on each spouse’s finances could create a conflict. The keys to navigating these potential clients are: (1) the attorney must get to know the spouses and their situation to identify potential conflicts; (2) the attorney must inform the client in clear and understandable written terms of the potential conflict; and (3) the attorney needs to get a written conflict waiver. There may be situations in which the spouses’ interests are so opposed to each other that separate counsel may be necessary. Even if a joint representation is possible, there could be parts of the engagement that require separate counsel. For example, if a marital agreement needs to be amended to allow for the SLAT planning, the estate planner can’t represent both spouses for that amendment.
Optimal Circumstances
WM. What are the optimal circumstances and timing for establishing a SLAT versus other estate-planning vehicles? Are there specific financial thresholds, family dynamics or market conditions that make SLATs particularly advantageous or inadvisable?
JD. It’s not surprising that SLATs are a popular tool among estate planners. A SLAT established in the right jurisdiction can allow for generations of transfer tax-efficient and creditor-protected planning. However, SLATs may not be right for everyone. If spouses will likely need to draw on the assets in SLATs, that invites a challenge from the Internal Revenue Service under Internal Revenue Code Section 2036. Likewise, spouses may have so much wealth that it would be more efficient and less prone to IRS scrutiny for the two spouses to create a single trust for their descendants.
Reciprocal Trust Doctrine
WM. How do you structure SLATs to avoid the reciprocal trust doctrine when both spouses want to create trusts for each other’s benefit? What practical differences in terms, timing and beneficiaries do you recommend to ensure that the IRS doesn’t consider the trusts reciprocal?
JD. The reciprocal trust doctrine is often perceived as the greatest threat to effective planning from a tax perspective. The problem is that while there’s a good understanding of the general concept of the doctrine after the Supreme Court’s 1969 decision in Estate of Grace, there’s been a dearth of clear guidance. It’s clear from case law and IRS guidance that worthless distinctions between trusts don’t avoid the doctrine, but there isn’t a clear list of what distinctions carry value and which don’t. This means the clients are effectively relying on the estate planner’s judgment on this issue. One suggestion is simply not to be cute. For example, having one SLAT created on Dec. 31 and the other SLAT on Jan.1 of the next year isn’t going to fool anyone. What’s more concerning now about SLAT planning isn’t the reciprocal trust doctrine, but other doctrines that can be applied. The reciprocal trust doctrine simply identifies who the transferor is for purposes of applying the string provisions in the Internal Revenue Code. There’s another doctrine, specifically the step transaction doctrine, which can also be applied to collapse related steps. If steps are being taken to create SLATs solely to avoid the reciprocal trust doctrine, then the step transaction doctrine could collapse those steps. Further, IRC Section 2036 applies when there’s an implied agreement for the grantor to retain control or benefit of the property. The facts surrounding the establishment of the SLATs and their operation can be construed in a manner that allows the IRS to assert an implied agreement. The key to effective planning is to be careful about what advice you and other advisors are giving that may not be privileged, and don’t be so hyper-focused on one tax issue (the reciprocal trust doctrine) that the tax planning fails for lack of consideration of other issues.
Effective Communication
WM. How do you effectively communicate the risks and limitations of SLATs to clients, particularly the potential loss of control over assets and the implications if the beneficiary spouse predeceases the grantor?
JD. The key to effective communication about the risks and limitations of SLATs is to be clear and do so in writing. Part of that is knowing your client and how they best digest information. For example, a numbers-driven client who’s motivated by the projected estate plan savings would be well served to see what the impact is of the beneficiary spouse dying first and what happens if there’s a divorce and ongoing costs to the grantor, such as the ongoing income tax liability while treated as a grantor trust.
