The Reciprocal Trust Doctrine (RTD) is a judicial principle (i.e., formed from case law under our common law system) that basically states that you can't have your cake and eat it, too. You should be aware of it when creating trusts as part of your estate plan.
The Purpose of Irrevocable Trusts
There are two main reasons to use an irrevocable trust.
The first is to reduce estate taxes. On a federal basis, that tax starts for a married couple at a net worth of $30 million [2026 — visit our annual numbers page to get the most up-to-date figures]. Assets placed into an irrevocable trust are no longer part of your estate. More importantly, the increase in value and any income produced by the asset is also outside of your estate. That means you don't have to pay estate taxes (as much as 40% federal plus sometimes a state tax as well) on that increase.
The second benefit of an irrevocable trust is an asset protection benefit. The asset no longer belongs to you. It belongs to the trust. If you get sued or have to declare bankruptcy, your creditor cannot take the assets in the trust, because your creditor has a claim on you, not the trust.
Maintaining Control
People with potential future estate tax problems are generally wise to take advantage of irrevocable trusts to reduce estate taxes and get a bit more asset protection at the same time. The downsides of the additional cost, complexity, possibly increased income taxes (trust assets don't get a step up in basis), and the loss of control must be weighed, but when compared to millions of dollars in estate taxes, one can put up with an awful lot of downside. If you're not going to use the money anyway, it makes sense to get it out of your estate. However, the problem comes in for people who are wealthy enough to have an estate tax problem but not so wealthy that they're ready to completely give up using the assets in the trust for themselves.
The chosen solution for these folks—and there are a few white coat investors in this category—is often a Spousal Lifetime Access Trust (SLAT). A SLAT also happens to be a great tool to use to understand the RTD, and perhaps the most likely place for it to be applied.
A SLAT is a type of Intentionally Defective Grantor Trust (IDGT). While that sounds bad, an IDGT allows the “grantor” or “settlor” (the person who funds the trust) to be responsible for its income taxes. Sounds bad, but it's actually a good thing. Trust income tax rates are particularly burdensome. You don't need very much trust income to get into the top tax bracket.
Drafted properly, a SLAT is a way to get your cake and mostly eat it, too. The assets are out of your estate for estate tax and asset protection purposes, but you can still control the assets as the trustee AND you can access/spend the assets because the beneficiary of the trust is your spouse. Assuming your spouse doesn't hate you, they're presumably going to share their house, food, car, boat, and money with you. So, you avoid estate taxes and protect the assets from creditors, and yet you still get to use the money—at least indirectly.
More information here:
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SLATs and the Reciprocal Trust Doctrine
Now, back to the RTD. Some people learn about SLATs and decide that it is an awesome idea. So, they decide to form two identical SLATs. One spouse is the grantor for the first and the beneficiary for the second, and vice versa. Voila! All that great protection from taxes and creditors, and you basically just split the money anyway, like many married couples do.
Not so, says the RTD. The RTD says if you do this, the trusts will just be treated like a revocable trust. No estate tax benefit. No asset protection benefit. The core principle is that if two trusts are sufficiently similar and leave the settlors in approximately the same economic position as if they had created trusts for themselves, they will be treated as such for tax purposes—and probably also for asset protection purposes.
Getting Around the Reciprocal Trust Doctrine
How do you get around the RTD and still use a SLAT as the primary piece of your estate/asset protection plan? You can effectively use two methods.
#1 Form Only 1 SLAT
The first method, which is the one we chose, is to just have a single SLAT. There can't be a Reciprocal Trust Doctrine if there is only one trust. Now, you can't BOTH be the beneficiary of a single SLAT, but as long as you both stay married (or at least draft the SLAT so it can be adjusted if you get divorced), it works out just fine.
#2 Don't Form Identical Trusts
The second method is to vary the trusts so that they are not identical. You can vary how much and what goes into each one. You can form them at different times. You can form them with different provisions or terms. You can use different trustees. You can put in meaningful differences in the powers granted to the beneficiaries and trustees of the trusts. You can do all of the above. You just need to show, in court if you have to, that you didn't just split your assets down the middle and pretend to give up control that you never really gave up to get tax and asset protection benefits.
Where Did the Reciprocal Trust Doctrine Come From?
The RTD came from a 1940 case involving two brothers, Lehman v Commissioner. These brothers made identical trusts for the benefit of one another, their children, and grandchildren. When the first brother died, the court “uncrossed” the trusts and ruled that the property that the deceased brother could have withdrawn from the trust created for the deceased brother's benefit was includable in the deceased brother's estate and, thus, subject to estate taxes. It was a quid pro quo. The court ruled that the brothers paid each other to create a trust for their own benefit.
The next big court case on this topic was in 1969, United States v Grace. Fifteen days apart, two spouses created substantially identical trusts. When the husband died, the Court ruled that the value of the assets of the trust created by the wife was includable in his estate. The case stated:
“. . . Application of the Reciprocal Trust Doctrine is not dependent upon a finding that each trust was created as a quid pro quo for the other. Such a ‘consideration’ requirement necessarily involves a difficult inquiry into the subjective intent of the settlors . . . As we have said above, standards of this sort, which rely on subjective factors, are rarely workable under the federal estate tax laws. Rather, we hold that application of the Reciprocal Trust Doctrine requires only that the trusts be interrelated, and that 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 life beneficiaries.”
Note that since the RTD comes from case law (a judicial principle), there is no safe harbor. There is no guarantee of when the RTD can and cannot be applied by a court.
More information here:
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SLATs, Death, and Divorce
Seems easier to just do one SLAT, right? But you need to think about two potential outcomes and draft the SLAT properly to deal with both of them. For example, a typical well-designed SLAT like ours has one spouse as the beneficiary, both spouses as “investment trustees,” and a third party as the “distribution trustee.” That works wonderfully well if the spouses stay together their whole lives and the beneficiary outlives the non-beneficiary spouse. But what happens when those things don't happen?
Death of the Beneficiary
Typically, if the beneficiary spouse dies, the assets in the trust are distributed to the secondary beneficiaries of the trust, typically the children of the couple. That's a problem if the living grantor spouse doesn't have any assets to live on and no longer has that indirect access to the trust assets that they had before via the beneficiary spouse. You can avoid this by keeping plenty of assets outside the trust. In our case, our retirement accounts and house are all outside the trust. However, another option exists.
The SLAT can be structured such that the non-beneficiary spouse can later be made a beneficiary. The trust can grant the beneficiary spouse a “testamentary limited power of appointment.” Thus, the beneficiary spouse's will indicates the non-beneficiary spouse will be a distributee of the trust. There is a little controversy here, too, of course. IRC 2036 talks about a “relation back doctrine” that would result in the assets being included in the estate after all. However, it has never been consistently applied. Revenue Ruling 2004-64 may provide an out as well, although state law may come into play.
In addition, the grantor can have the power to appoint a trust protector who can have the power to appoint the grantor as the beneficiary. We have this in our trust.
Still, it's best if the beneficiary is the one least likely to die first. Since Katie is less risky than I am with physical activities, is younger than me, and is a woman (women live longer on average), it seemed obvious to us to make her the beneficiary spouse.
Divorce
What happens in a divorce? For a detailed discussion, check out this article by Christen Douglas and Joseph Viviano. Three issues are at play. The most obvious is the access to assets issue. The non-beneficiary spouse theoretically no longer has access to the assets in the trust via their spouse. However, the trust document can be written such that the non-beneficiary spouse does not remain a beneficiary or even a trustee after the divorce. It might be all about specifying what “spouse” means. If it isn't defined in the trust document, courts have actually ruled opposite ways about whether the spouse is still the beneficiary after a divorce.
Even if not defined, other options are available at the time of divorce. These include:
- Exercise of a power of appointment (such as a new distribution trustee)
- Decanting of the trust into other trusts
- Judicial or non-judicial reconstruction of the trust
- Reformation, modification, or termination of the trust
A post-nuptial agreement could also come into play.
Our attorney didn't even bother defining “spouse” as the person to whom I'm married at the time of distribution. He just put in this line:
“However, spouse shall be removed as trustee and be treated for all purposes hereunder as though she died when she and I became divorced.”
Either the new trust beneficiaries are just our kids and our foundation and neither of us can access the trust assets for our own good, or we've got to come to some sort of agreement to decant the trust into new trusts. Seems like the motivation to do that would be high for both of us in that situation.
It's probably best to change the trust in some way at the time of divorce because keeping the trust in its current form brings the two other issues into play.
The first of these is estate/transfer tax issues. The grantor may have already used up their estate tax exemption to fund this trust, and they would have to pay gift taxes on additional future transfers. The second is income tax issues. The beneficiary spouse gets to spend the income and assets in the trust, but the grantor spouse has to pay the taxes on that income.
Trust provisions and changes made at the time of divorce can address and equalize these issues, but they may be problematic and costly if the beneficiary spouse elects, as often occurs, to fight to maximize their share of assets after the divorce. The bottom line is that the divorce agreement needs to be very specific with regard to how the SLAT is going to work after the divorce if it is not dissolved at the time of divorce. Potential resolutions include the beneficiary spouse releasing part or all of their interest in the SLAT in exchange for non-SLAT assets. It could also require the beneficiary spouse to reimburse the grantor spouse for income taxes due on SLAT income.
The bottom line is that divorce should be avoided if at all possible, but if that's not possible, the SLAT should provide sufficient power to the grantor spouse so a reasonable outcome is ensured in the event of divorce. It's best if the SLAT document or a separate agreement memorializes that the assets contributed to the SLAT were marital property and whether the beneficiary spouse will remain a beneficiary in the event of divorce.
The RTD and related issues are important for the attorney and the clients to understand when using complicated estate planning techniques like SLATs.
What do you think? Have you used or considered using a SLAT(s)? How did you get around the RTD? What provisions do you have in place in case of divorce or the death of the beneficiary spouse?