We lawyers love fancy names and acronyms. It keeps the estate planning process mythical and a bit veiled. Reality is, many of the fancy names given to trusts and other planning techniques obfuscate what is really going on. While that makes for great talk on the golf course (“Hey we just got back-end SLATs”) it doesn’t help make the planning more understandable. So, let’s demystify the latest estate planning catch phase “back end SLAT.” When we’re done it is basically a high grade traditional life insurance trust (that’s easy to understand) that gives the person setting it up (called the settlor, trustor or grantor) an extra shot at getting access to the money in the trust. In the immortal words of Porky Pig (or was it Elmer Fudd?) “That’s all folks!”
Let’s define the incomprehensible acronyms above, then we’ll give you the scoop on the new catch phrase “back door SLAT.”
ILIT – this is an irrevocable life insurance trust. Traditional insurance trusts have been ubiquitous in estate planning since pre-historic times. A common example is Husband buys life insurance so if he dies prematurely his spouse and kiddies are provided for financially. Because of the risks of estate tax (especially long ago when the exemption was much lower), his spouse remarrying after his death, and other financial risks (his surviving spouse is imprudent in managing the money, or gets sued, or both parents die and the money must be protected for the kids) the insurance was commonly put in a trust. By the way, for all those non-tax reasons life insurance should still commonly be held in a trust. It was also common to buy life insurance on the wife/mother because if something happened to her caring for the children, especially when they were little, was a cost to address. A life insurance policy on the wife/mother held in a trust she created was also commonly used (although less so than the trust for husband as these policies were often smaller). As it became the norm for spouses to also be employed in the labor force the policies insuring the lives of the wife/mother grew bigger and the use of trusts to protect those policies more common. Bam! Husband created a trust for the wife and kids and the wife created a trust for husband and kids. That became a common estate planning technique.
SLAT – Spousal lifetime access trust. As the exemption grew it became common for couples to want to use up some of their estate tax exemption, but unless they were super-wealthy (now, like $30-$50 million and up) couples couldn’t give away assets they could not get access to. So, Husband created a trust for the wife and kids and the wife created a trust for husband and kids. Yes, if you’re reading carefully the prior sentence is the same sentence used to describe ILITs or the common insurance trust in the preceding paragraph. But if we called this not really new technique “ILIT” it would have less appeal then using the new acronym SLATs. To be fair, trust drafting and trust laws have evolved substantially since the old style insurance trusts so a modern day SLAT is likely more robust and flexible than the insurance trust drafted a decade or more ago. But the concepts are still pretty much the same. New acronym more excitement!
DAPT – Domestic asset protection trust. This is a trust you can create for your spouse and kids but you too can be a beneficairy if you create the trust in one of the now 19 states that permit these types of trusts. Conceptually, a DAPT (also called a self-settled trust because you created or settled it for yourself, or an asset protection trust because a goal is to protect the assets in the trust for yourself) is not all that different than the traditional ILIT (of course updated for modern trust drafting as mentioned above in the comments on SLATs) with an extra couple of sentences that permit you to be a beneficiary too. And, oh yes, if the state law where the DAPT is created requires certain language be included that should be included too.
Hybrid DAPT – this is a self-settled trust or DAPT just as in the preceding paragraph but you are not a beneficiary when the trust is first created. Instead, someone acting in a non-fiduciary capacity (e.g. not as a trustee) is give a limited power or right to add new beneficiaries to the trust. That new beneficairy can be you, or we can be more obtuse and say any descendant of your maternal grandmother. Geeze that includes you too! So, conceptually, a Hybrid DAPT is kinda like the old insurance trust (with modernized provisions), created in a state that permits self-settled trusts, that has an extra paragraph that lets someone add you in as a beneficairy. The Hybrid-DAPT is similar to the DAPT but instead of you being named there is a mechanism to add you in. The Hybrid-DAPT concept was created to address the concern of: “I live in a state that does not permit self-settled trusts so if I set up a self-settled trust in another state will my state respect it?” So someone in NY or CA sets up a DAPT in AK or SD they might feel more comfy having it as a Hybrid-DAPT than a straight up DAPT. It’s also a cooler sounding name for when you’re on the links: “Hey we just got a Hybrid-DAPT!”
SPAT – Special power of appointment trust. So, consider again that you live in a state whose laws don’t permit self-settled trusts or DAPTs. Your lawyer offers you a Hybrid-DAPT, but your wealth adviser suggests you can do one better by getting a SPAT (and you’re immediately thinking you can brag to your golf partners: “Hey we just got SPATs.” The idea of the SPAT mechanism a person acting in a non-fiduciary capacity (not a trustee) can direct the trustee to make a distribution to you. That person, just like in the Hybrid-DAPT holds a limited or special power to direct the trustee to make a payment of trust assets to you. What’s the key legal or conceptual difference between a SPAT and Hybrid-DAPT? Well, in the DAPT or Hybrid-DAPT you either are or become a beneficiary of the trust. So, if you live in a state that doesn’t permit self-settled trusts (i.e., any state other than the current 19 states that do permit them), if you become a beneficairy there is a risk that your state courts if you are sued will try to attack the trust arguing that your home state laws, not the laws of the DAPT state, should apply. How big is that risk? Like most estate planning techniques no one can measure or quantify it. Some commentators suggest that there have been very few cases unraveling these types of trusts in the more than 20 years since self-settled trust legislation was first introduced in the US (The Alaska Trust Act became effective on April 2, 1997, as a counter to the foreign asset protection trusts that had been in use for much longer). Most or some might argue all of those cases were bad fact cases where those involved did bad planning or bad acts or both. Other pundits may argue that there are Constitutional issues and that a non-DAPT state could pierce a self-settled trust even if properly formed in one of the current 19 states that permit them. Given the potential murkiness of this some smart estate planners “created” this new concept they called a SPAT. The word created is in quotation marks because the use of special or limited powers to appoint trust assets has been around for a long time, they just kinda tweak the context or application of it in a creative way. Why might a SPAT be a safer option than a DAPT or Hybrid-DAPT? Because, the argument goes, you are never a beneficiary of the trust. The trustee never can make a decision about giving you a distribution but is directed to do so by a third party (independent person).
By the way, in all of the above techniques of the insurance trust (ILIT), spousal lifetime access trust (SLAT), domestic asset protection trust (DAPT), Hybrid-DAPT, or special power of appointment trust (SPAT) a court at the behest of a claimant or the IRS might try to pierce the transaction saying you had a side deal (implied agreement) with all the folks involved to get at the money in the trust that was supposed to be outside of your estate for tax purposes and outside the reach of your creditors. Well, if all these folks are playing footsie under the trust covers, that could be an issue. That’s why for any trust to have a shot at achieving your objectives you’re best off naming an independent institutional trustee (yes, a trust company), really independent people to serve in any of the capacities involved in the trust, and meet with your professional advisers yearly to be sure that the trust is being administered properly. Way too few folks seem to do that since that doesn’t provide any cool new things to say before teeing off.
Now, with all the above background and all these techniques explained (in really basic terms) you realize we need a new hot name for a similar technique. Why? Because the exemption (the amount you can transfer without gift or generation skipping transfer tax) is set to be cut in half in 2026 unless Congress changes the law. That reduction was baked into the 2017 Tax Cut and Jobs Act and will happen, again unless Congress can agree otherwise. So, lots of wealthy folks, and even some moderately wealthy folks should be using up some or all of their current $12,920,000 exemption amount before 2026 to lock it in and safeguard it. If you are uber wealthy you don’t need a fancy trust you can just put the money in a trust for your heirs and call it a day. But if you’re wealthy but not uber wealthy you may be uncomfortable putting big chunks of wealth into a trust you will never see again. So you need to use some combination and variation (and there are lots of variations) of the techniques discussed above. The objective is to achieve the dual goals of: (1) moving assets outside of your taxable estate (and outside of the reach of potential future creditors); and (2) having some access to those assets in case you need them in the future, but without undermining goal number (1). Reality check – every point or mechanism that gives you access, whether it is the right to get your income taxes reimbursed that you paid on trust income (a tax reimbursement clause), a loan provision, a SPAT power of appointment, being named a beneficiary, your spouse as a beneficiary, etc. all add additional risk of the IRS arguing estate inclusion or a creditor trying to reach the assets. That doesn’t mean you should not add whatever mechanisms that you feel you need to be comfortable, just be mindful that each adds some risk. Just to keep the planning process clear and honest, no one can measure the incremental risk of any access mechanism added to a trust (whatever type). No one can tell you: “Geeze, adding a Hybrid-DAPT provision to your SLAT (which is just a fancy ILIT) will add a 12% increase in the likelihood of estate inclusion.” There just are no measuring sticks for any of this. But, you should know with confidence that properly administering whatever trust and mechanisms may reduce those risks. But, and now you’re expecting the point, that too cannot be measured.
So, given the crush of trust planning before 2026, and the need to accomplish the dual goals above, what do you really need to make your planning more exciting? YES a new hot name. Enter the “Back Door SLAT.” If you get one of these puppies you can be assured that you’re getting the latest and greatest tax planning moniker. How cool is that?
So what is a “Back Door SLAT?” Some state laws permit say the husband to establish a trust for the wife, and the wife can, on her death appoint (doesn’t that sound a bit SPAT-like?) the assets in trust back to the husband. That appointment back could be to a trust for husband (the spouse that set up the initial trust) and descendants. So that new or second trust funded on the wife’s death is kinda like the bypass or credit shelter trust that has commonly been used in wills for decades. It is also kinda like the traditional insurance trust. The result is kinda like having a Hybrid-DAPT that adds the husband back as a beneficiary of a new or second trust when the wife dies. So, why is it called a “Back Door SLAT?” Because the husband is added back as a beneficiary after the wife dies, kinda as if through the back door. Understand that you have to be sure that the state law of the state where you create this so-called back door SLAT permits this type of planning. If state law doesn’t facilitate this the second or back door trust that names the husband could be treated as a self-settled trust and therefore be reachable by the husband’s creditors and included in his taxable estate effectively ruining the plan. While you could certainly set this all up in one of the 19 states that permit self-settled trusts, many other states that do not have self-settled trust laws, have enacted special rules to permit this trust for wife with appointment back to husband, or if you prefer, Back Door SLAT, technique to work. You just have to check your state’s laws. But many of these special laws have pretty specific requirements that have to be met to qualify for this treatment. As an example, Florida modified its rules on July 1, 2022 to permit this technique.
So should you use an ILIT, SLAT, DAPT, Hybrid-DAPT or Back Door SLAT? The reality is that if you and your spouse are both setting up trusts and doing planning you might each pick a different acronym so that the rights you each have after the trusts are created are different. That is important to avoid a tax and creditor protection trap known as the “Reciprocal Trust Doctrine.” Under that doctrine if the trusts are too similar, if you and your spouse are essentially left in the same economic position after the trust plan as before, the trusts can be uncrossed and your plan may fail.
What you should try to do is parse with your advisers through the alphabet soup of trust acronyms and pick the approaches that make the most sense for you, and balance your tax and asset protection concerns versus your need to access assets given away, all while avoiding the reciprocal trust doctrine. Better to focus on your situation and your wishes and needs, not the coolness of the acronym picked. Some pundits suggest go to a state that permits self-settled trusts even if you use any other technique, and name an institutional trustee as both those steps may make your plan safer. But whatever plans/trusts you choose, be sure to meet annually with all of your advisers and key persons involved and make sure the proverbial i’s are dotted and t’s crossed as proper administration and adherence to formalities is absolutely critical to have a likelihood of accomplishing your goals.
“A rose by any other name would smell as sweet,” but an estate planning acronym by any other name may sound like a new and improved rose, but be careful it may not be as tax-sweet.