Spousal Access Trusts - Reciprocal Trust Doctrine

Spousal Access Trusts are irrevocable trusts in which an individual makes lifetime gifts for the benefit of the spouse and typically other family beneficiaries. The assets are removed from the grantor's estate, yet because the spouse is one of the beneficiaries, the grantor can still indirectly benefit from the trust. Many individuals are using the increased gifting exemption of $5 million in 2011-2012 as an opportunity to transfer substantial assets. While the primary issue with a single spousal access trust is the selection of trustees and the distribution standard to ensure that the property will not be included in either spouse's estate, when two trusts are created an additional concern is the "Reciprocal Trust Doctrine."

Trustee: Selection and Distribution standard

One option to avoid the assets being included in either spouse's estate, is to appoint an independent trustee with a discretionary distribution standard. However, many times, it is desirous that the beneficiary-spouse be a trustee, in which case the distributions must be limited to an ascertainable standard. Additionally, it is critical that the trust assets cannot be used to discharge the grantor's support obligation. Attorneys will typically either include a savings clause that prevents the trustee from making a distribution that would discharge the grantor's support obligation, or a clause that requires the trustee to look at the beneficiary's other resources, including the grantor's support obligations, before making a distribution.

Reciprocal Trust Doctrine

The Reciprocal Trust Doctrine addresses circumstances where parties create two trusts benefitting the same persons, but in the end, each party is in essentially the same situation as if the trusts had not been created. The seminal case is Estate of Grace¹, a U.S. Supreme Court case. The trusts created by Mr. and Mrs. Grace named each other as beneficiaries, contained substantially identical terms, and were created 15 days apart. The court "uncrossed" the trusts and concluded that Mr. Grace's estate should include the value of the trust established by Mrs. Grace in which he was a beneficiary, as if he had established and funded the trust himself. The Grace case held that the reciprocal trust doctrine should apply when (1) the trusts are "interrelated" and, (2) the arrangement leaves the two grantors in "approximately the same economic position" as if each had created a trust and named himself or herself as beneficiary.

Working Around the Reciprocal Trust Doctrine

Since Grace, no cases have been reported that deal directly with spouses creating trusts for each other, but subsequent cases have interpreted the reciprocal trust doctrine in other situations. Additionally, several Private Letter Rulings (PLRs) have been issued that deal with spousal trusts. PLRs are binding only to the parties involved and cannot be used as precedent, but they can offer valuable insight into what the IRS is willing to accept.

The Tax Court found that trusts were reciprocal when both the husband and wife created trusts for their grandchildren, and appointed each other as trustee with the discretionary right to make distributions². The court said that each spouse had the power to alter distributions and had not given up control. In another case, husband and wife had established two UGMA accounts and named each other as custodians³. When the husband died, he was serving as custodian of the trust the wife had created and the court included those assets in his estate.

In reviewing cases and PLRs⁴ which have found trusts not to be reciprocal, no "bright lines" have been set as to what differences are sufficient to escape the "uncrossing" of the trusts. However, following is a list of some of differences in the trusts that the courts and the IRS examined.

The options are limitless, but other variances one could consider incorporating in trusts could include:

The Nautilus Group is a service of New York Life Insurance Company. This writing reflects an understanding by The Nautilus Group® of generally applicable rules and is for informational purposes only. This material includes a discussion of one or more tax-related topics. This tax-related discussion was prepared to assist in the promotion or marketing of the transactions or matters addressed in this material. It is not intended (and cannot be used by any taxpayer) for the purpose of avoiding any IRS penalties that may be imposed upon the taxpayer. Taxpayers should always seek and rely on the advice of their own independent tax professionals. Please understand that New York Life Insurance Company, its affiliates and subsidiaries, and agents and employees of any thereof, may not give legal, tax or accounting advice to you. 457372-1 9/22/2012