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  • Writer's pictureErin E. McQuiggan, Esq.

Countdown to the Sunset of the TCJA: Revisiting the Reciprocal Trust Doctrine

Updated: 15 hours ago


As every estate planning practitioner knows, the exemptions from federal gift, estate and generation-skipping transfer taxes (collectively “exemptions”) are at an all-time high, due to the changes under the 2017 Tax Cuts and Jobs Act (“TCJA”). Absent the passage of further legislation, the provisions of the TCJA that increased the exemptions will sunset on December 31, 2025, and the exemptions will revert back to $5,000,000 (adjusted for inflation). If that happens, to the extent a client has not used the increase in the exemptions, they will be lost.


There is a window of time to put tax-efficient estate plans into place, but the clock is certainly ticking. Advisors must alert clients who may be subject to gift and estate taxes to this limited time frame and take steps to help them utilize the increased exemptions, if doing so is the right planning for them. It goes without saying that there are numerous estate planning techniques available to take advantage of the current exemptions and efficiently transfer wealth while still advancing an individual’s other lifetime goals. Of these planning techniques, one of the most popular strategies for married individuals is the establishment of a Spousal Lifetime Access Trust (“SLAT”).


SLATs are defective grantor trusts that facilitate the movement of assets out of an individual’s taxable estate and into a trust of which their spouse is a permissible beneficiary. Following the death of the beneficiary-spouse, the assets in the trust are typically passed to younger generations without triggering an estate tax or a generation-skipping transfer tax. In effect, SLATs provide an avenue for removing assets from both spouse’s estates while allowing the beneficiary-spouse access to such assets if a need arises. This flexibility has made the SLAT strategy widely popular.


SLATs are most definitely not a new strategy in the world of estate planning, but in this current environment, provide a tool to encourage clients to consider giving away significant assets. While planning for two SLATs simultaneously is risky (as discussed below), many clients do end up putting two such trusts in place. For example, the first SLAT may have Spouse A as the grantor and Spouse B as a permissible beneficiary. The second SLAT could use Spouse B’s exemptions and have Spouse A as a permissible beneficiary (although that does not have to be the case, and there are ways to add a spouse as a discretionary beneficiary at a later time). Using two SLATs allows married couples to use both of their exemptions while hedging against the unexpected death of a beneficiary-spouse or unexpectedly needing access to the transferred assets. In this scenario, the SLATs are typically put into effect under separate planning, at different times and with different assets, to avoid the notorious “reciprocal trust doctrine.”

Given the impending sunset of the increased exemptions, the use of SLATs is bound to increase in the coming months for married couples who have yet to use all their available increased exemptions. With this uptick, and the possibility of the need for rushed or hurried planning prior to the end of 2025, it is likely that clients and planners will feel pressure to create simultaneous SLATs or to fund SLATs with the same type of assets. As a result, it is vital that planners re-familiarize themselves with the reciprocal trust doctrine. The reciprocal trust doctrine creates a rule which, if ignored or forgotten, may disrupt an otherwise carefully constructed estate plan. If the reciprocal trust doctrine is found to apply, assets that were previously transferred out of an individual’s taxable estate effectively will be pulled back into their estate at death. For those planning with clients who have assets nearing the exemption limits either before or after the sunset of the increased estate tax exemptions in 2025, it is important to discuss the financial and family implications of such planning along with the associated risk of estate inclusion.


As seen in various other areas of the law, the focus of the reciprocal trust doctrine is substance over form. [1] The reciprocal trust doctrine works to prevent a situation where the form of the transaction appears to remove assets from the grantor’s control by transferring them to a trust in which the grantor retains no interest, but the substance of the transaction leaves the grantor in the same position as before the transaction because another trust is created by a different individual for the benefit of the grantor and therefore he or she gains a similar interest in property. [2]


Although the reciprocal trust doctrine has been around for over eighty years, the rules are not found in the Internal Revenue Code or the Treasury Regulations. In addition, despite various cases directly addressing the reciprocal trust doctrine and further guidance issued by the Internal Revenue Service (“IRS”) in the form of Private Letter Rulings, much of the doctrine remains a grey area. For this reason, planners must often make judgments based on the limited guidance and his or her interpretation of the case law. Consequently, not all planners agree on the necessary requirements to avoid the doctrine, and some planners may be more conservative than others.


The commanding authority on the reciprocal trust doctrine dates back to 1969, when the Supreme Court issued its ruling in United States v. Estate of Grace.[3] In an opinion unfavorable to the taxpayer, the Court concluded that the assets of a trust established by the decedent’s wife must be included in the taxpayer’s gross estate. In Estate of Grace, a husband and wife each established trusts at around the same time in which the terms were “virtually identical,” and each named the other as a beneficiary. The Court found that the reciprocal trust doctrine applies where: (1) the trusts are interrelated; and (2) the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as beneficiaries. The decision in the Estate of Grace refined former case law that based the application of the doctrine on the subjective intent of the parties.[4]


Apart from providing the two-prong test and applying it to a specific set of facts, Estate of Grace did not offer any significant additional guidance on the definition of interrelatedness or how to determine if the settlors are in approximately the same economic position. However, many decisions analyzing the doctrine tend to focus on assessing interrelatedness. Some of the factors courts have considered include:


  • the timing of trust creation and whether the trusts were created pursuant to a prearranged plan;

  • the similarity of the trust terms;

  • the identity of the trustees;

  • the beneficiaries and whether they are the natural objects of the grantor’s bounty; and

  • the assets that were transferred to each trust.[5]


In addition to the above factors established throughout case law, the IRS has issued several Private Letter Rulings that are instructive (although they may not be relied upon by other parties). In PLR 9643013, the IRS concluded that trusts established by a husband and wife were not interrelated where the current beneficiaries were not the same and the powers of appointment differed. The husband established one trust for the benefit of his descendants, where the wife was granted a power of appointment exercisable in favor of the husband’s descendants and each of their respective spouses. The wife established a trust for the benefit of her husband and descendants where the husband did not have a power of appointment. Instead, the special power of appointment was granted to the independent trustee.


In PLR 200426008 the IRS found that trusts established by a husband and wife were not interrelated due to the differences in withdrawal rights, powers of appointment and current beneficiaries. In the trust established by the husband, the wife had a special power of appointment exercisable in favor of the husband’s descendants and each of their respective spouses and limited withdrawal powers after her son’s death. In the trust established by the wife, the husband was not able to receive distributions from the trust unless certain timing and income related requirements were met.


The reciprocal trust doctrine also has been applied in cases outside of the area of estate tax,[6] and even in situations that did not involve trusts.[7] Krause v. Commissioner is of particular relevance.[8] In Krause, a husband and wife each created trusts naming the other and their descendants as beneficiaries. The trusts named the non-grantor spouse as trustee and were otherwise identical. Although dealing with the implication of income tax, the court applied the reciprocal trust doctrine and concluded that the trusts were interrelated and therefore the reciprocal trust doctrine applied. A similar finding was made in PLR 8813039.


Courts also have diverged on whether or not a grantor must retain an economic interest in the trusts that are established. In Estate of Bischoff v. Commissioner, the court found that the reciprocal trust doctrine applied where a husband and wife created identical trusts for the benefit of their grandchildren and each named the other as trustee.[9] Though neither the husband nor the wife was a beneficiary of any of the trusts, the court held that substantial economic interest is not a requirement. The Sixth Circuit rejected this line of reasoning in Estate of Green v. United States which presented a similar set of facts to Estate of Bischoff. In Estate of Green, the court instead found that a retained economic benefit was a “core mandate” of the Estate of Grace ruling and thus required for the reciprocal trust doctrine to apply.[10]


When designing an estate plan for married couples, the use of two SLATs is often preferred. Not only do SLATs make clients more comfortable to use their significant exemptions by allowing potential access to transferred assets, they also provide for the benefit of symmetry when passing wealth, particularly in circumstances where the assets between spouses are intertwined. In addition, using two SLATs may reduce concerns regarding a divorce that could happen after the creation of one or two SLATs (although in the event of divorce, even having used two SLATs could place the spouses in very different economic positions).


To avoid application of the reciprocal trust doctrine when planning with two SLATs, estate planners must consider the factors that have been attacked in the past and the specifics of the planning scenarios in which the reciprocal trust doctrine has been found to apply. The creation of SLATs should not be dependent on each other or leave the spouses in exactly the same economic position. As a result, it is better to create them in different tax years and fund them with different assets.


Although helpful in avoiding the doctrine, naming different beneficiaries can present some drawbacks. In most estate plans both spouses will want their wealth to pass to their children and grandchildren, which means that the remainder beneficiaries of the SLATs will often be the same. Planners may be able to institute different permissible present beneficiaries to keep the SLATs from being considered too similar. For example, having one spouse be the only current beneficiary of one SLAT and the other spouse and descendants be current beneficiaries of the second SLAT may help validate differences between the trusts.


Since some of these factors may be difficult to avoid, planners often attempt to evade the application of the doctrine by varying other trust terms so they will not be found to be interrelated, perhaps relying on one of the most pro taxpayer rulings, Estate of Levy.[11] The facts in Estate of Levy involved a husband and wife who created identical trusts for the benefit of one another, with the exception of different powers of appointment. In the trust where the husband was the grantor, the wife had a special power of appointment exercisable in favor of anyone but her estate, her creditors and the creditors of her estate. The husband did not have a similar power in the trust set up by his wife. The court found that this singular difference was sufficient to conclude that the trusts were not interrelated and therefore not reciprocal. The court also emphasized the fact that the likelihood that wife would actually exercise her power of appointment was not relevant.


Although a major success for taxpayers, the court was careful to narrow its holding in Estate of Levy by finding that the specific facts of the case were a major consideration in the outcome. The special power of appointment granted to the wife was enough, if exercised, to shift control of the family-owned corporation. The court did not address whether the outcome would be the same if the facts had differed.


While the Estate of Levy is instructive, the decision leaves unanswered questions. Planners must ask how many differences are enough in each particular situation and which differences, if any, carry a heavier weight. Relying on Estate of Levy, drafting each SLAT to contain different powers of appointment is a great starting point. However, given that the Estate of Levy did not unequivocally conclude that the singular difference in appointment powers would be enough to avoid the doctrine in all situations, planners should consider including other differences in the SLATs as well. Divergence in the two SLATs may be accomplished through the use of different beneficiaries, different trustees, dissimilar distribution standards or the inclusion withdrawal rights.


Despite the varying conclusions that may be drawn by planners regarding what constitutes interrelatedness and how best to accomplish the differences needed to avoid the finding of reciprocity, it is essential that the reciprocal trust doctrine is at the forefront of consideration when instituting estate plans that utilize multiple SLATs.

Without the benefit of additional time as new estate planning clients come out of the woodwork over the next year, estate planners need to consider what options they wish to present to clients and if those options should include simultaneous SLAT planning. The foregoing discussion of the application of the reciprocal trust doctrine should serve as a reminder to every estate planner to craft SLATs carefully. When doing so, it is critical to think through what differences are necessary to impede the ability of the IRS to unwind the estate plan and force the payment of estate tax.


Erin E. McQuiggan is a Partner in the Private Client Services group at Duane Morris LLP. Erin advises clients in all aspects of estate planning, estate and trust administration, and taxation matters. She is a board member of the Philadelphia Estate Planning Council and an adjunct Professor for the Graduate Tax Program at Temple University Beasley School of Law.


Kristina A. Miller is an Associate in the Private Client Services group at Duane Morris LLP. Kristina assists with matters relating to estate, trust and tax planning. She earned her JD from Temple University Beasley School of Law in 2023.



[1]

See Exch. Bank & Tr. Co. of Fla. v. U.S., 694 F.2d 1261, 1265 (Fed. Cir. 1982) (“The reciprocal trust doctrine is essentially a specific application of ‘substance over form.’”).

[2]

Est. of Levy, 46 T.C.M. (CCH) 910 (1983).

[3]

395 U.S. 316 (1969).

[4]

Lehman v. Comm’r, 109 F.2d 99 (2d Cir. 1940).

[5]

Est. of Levy, 46 T.C.M. (CCH) 910 (1983). See also Est. of Bischoff v. Comm’r,

69 T.C. 32 (1977); Krause v. Comm’r, 57 T.C. 890 (1972); Exch. Bank & Tr. Co. of Fla. v. U.S., 694 F.2d 1261 (Fed. Cir. 1982).

[6]

See Sather v. Comm’r, 251 F.3d 1168 (8th Cir. 2001) (addressing annual exclusion gift trusts); Est. of Schuler v. Comm’r, 282 F.3d 575 (8th Cir. 2002) (also addressing annual exclusion gift trusts).

[7]

Exch. Bank & Tr. Co. of Fla. v. U.S., 694 F.2d 1261 (Fed. Cir. 1982) (holding that the reciprocal trust doctrine may apply in the transfer of property via custodianships).

[8]

57 T.C. 890 (1972).

[9]

69 T.C. 32 (1977).

[10]

Est. of Green v. U.S., 68 F.3d 151 (6th Cir. 1995).

[11]

Est. of Levy, 46 T.C.M. (CCH) 910 (1983).

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