The Spousal Access Trust

This little-known strategy takes advantage of gift-tax exemptions and still allows spouses to use gifted funds during their lifetimes.

Can you transfer your business to your children, yet keep control and enjoy your company’s income for life? The answer to each of these three questions is yes. And there are a number of strategies that will allow you to do this. One lesser-known one, the spousal access trust (SAT), is one you should consider.

“Joe,” a long-time reader of this column from Ohio who is now retired and living in Florida, asked me to create an estate plan for him that included transferring his business to his son “Sam” using an intentionally defective trust (IDT). Sam already runs the company, Success Co., which is a C corporation. 

Joe’s background and circumstances are the same as or similar to those of most of the readers who call me with a business succession problem. He is 64 years old and married to Mary, age 63. They do not have a huge estate tax problem because their estate, which is valued at $5.7 million, is not worth enough. This $5.7 million includes $1.7 million in their Ohio and Florida homes; $800,000 in a traditional IRA; a $500,000 stock and bond portfolio; land and a building leased to Success Co. worth $1.1 million; $100,000 in cash; and, finally, the business itself, which is worth about $1.5 million.

Success Co. takes in about $300,000 per year, on average, after paying Joe a salary of $95,000. (Although Joe is retired and living in Florida, he still consults with Sam by phone, fax and email.) The plan is to discontinue this salary when Joe and Mary can enroll in Medicare and get off the company’s health care plan. At that point, Sam planned to buy Joe’s stock in the company (he owns 100 percent) over a 10-year period using an IDT. The IDT would purchase 10 percent of the stock each year at a cost of $140,000 annually. 

Both Joe and Mary are healthy, and according to the latest life expectancy tables, he will likely live at least another 18 years and she another 27 years. As outlined above, the $140,000 they would receive annually from the sale of Success Co.’s stock would stop after 10 years, and only heaven knows how much inflation will have reduced the value of their spendable dollars.

After some discussion, Joe agreed that the plan of using an IDT to transfer the company to Sam would not work well if he and Mary were lucky enough to enjoy long and healthy lives. 

Other methods for transferring a company’s stock also would be problematic. A direct sale kicks up capital gains taxes. A gift of the stock means no further income to Joe and Mary. Variations of these methods suffer one or both disadvantages. And inflation remains an unknown fear factor for as long as Joe and Mary live. 

In the end, we instead used the SAT strategy to transfer Success Co. to Sam. Here’s how:

The first step was to change the company’s status from a C corporation to an S corporation in which Joe and Mary each own 50 percent of its nonvoting stock. Note: If a company does not already have voting and nonvoting stock, a simple tax-free transaction can create them. Typically, the company’s owner, Joe in this case, will keep the voting stock (say, 100 shares) and control of the company, and the nonvoting stock (say, 10,000 shares) can be gifted to an SAT. In this case, Joe and Mary can each use a portion of the $5.43 million gift-tax exemption to which they are entitled to gift 5,000 shares of nonvoting stock to SATs in each of their names. (Nonvoting stock is entitled to various discounts totaling about 40 percent, so the 10,000 shares in Success Co., although valued at $1.5 million, could be gifted to the SATs at a value of about $900,000 for tax purposes.)

In simple terms, Joe’s trust gives Mary a right to the trust income for the rest of her life, and Mary’s trust does the same for Joe. After both have died, the trusts’ assets go to their heirs. It is critical that each trust be drafted in such a way as to be different, however, in order to avoid the so-called “reciprocal trust doctrine” that would pull the gifts back into their estates. If you want to employ this strategy, make sure you work with an advisor who is experienced in drafting and working with SATs.

SATs operate on a year-to-year basis: Joe and Mary are limited to working only with their spouse’s trust to get the income they need. Any funds that they do not take stay in the trust and will eventually go to their heirs—estate-tax-free, of course.

As a result of using this SAT strategy, 1) Success Co. is out of Joe’s estate, although he remains in control of the company for as long as he lives; 2) income earned by Success Co. will continue to be available to Joe and Mary as needed; and 3) after Joe and Mary die, the company will go to Sam and all unused income that remains in the SATs will go to their heirs—free of estate taxes.