A Spousal Lifetime Access Trust is treated as a grantor trust whenever its terms include at least one power or interest described in Internal Revenue Code Sections 671 through 679. In practice, almost every SLAT qualifies automatically under Section 677, because trust income can be distributed to or accumulated for the grantor’s spouse. Most drafters add a second, independent trigger — typically the power to substitute assets of equivalent value under Section 675(4)(C) — so the classification survives events that would otherwise end it. The result is that the grantor, not the trust, pays income tax on the trust’s earnings.
Section 677 Makes Almost Every SLAT a Grantor Trust
Section 677 treats the grantor as owner of any portion of a trust whose income can be distributed to the grantor’s spouse, accumulated for the spouse’s future benefit, or used to pay premiums on life insurance covering the grantor or spouse.1Office of the Law Revision Counsel. 26 US Code 677 – Income for Benefit of Grantor The entire design of a SLAT depends on the beneficiary spouse being able to receive distributions, so the Section 677 condition is satisfied the day the trust is funded.
Section 672(e) reinforces the result. Under that spousal unity rule, the grantor is treated as holding any power or interest held by the grantor’s spouse at the time the trust was created.2Office of the Law Revision Counsel. 26 USC 672 – Definitions and Rules The spouse’s right to receive trust income is attributed to the grantor, and Section 677 does the rest.
Because the trust is a grantor trust, all of its income, deductions, and credits flow through to the grantor’s personal return.3Office of the Law Revision Counsel. 26 US Code 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners The trust exists as a separate entity for estate and gift tax purposes but is ignored for income tax.4Office of the Law Revision Counsel. 26 US Code Subtitle A Chapter 1 Subchapter J Part I Subpart E – Grantors and Others Treated as Substantial Owners
The Swap Power as a Backup Trigger
Section 677 is enough on its own, but it depends on the continued existence of a spouse-beneficiary. That is why most SLATs include a second, independent trigger. The most common choice is the power to reacquire trust assets by substituting property of equivalent value, exercisable in a non-fiduciary capacity, under Section 675(4)(C).5Office of the Law Revision Counsel. 26 US Code 675 – Administrative Powers
The swap power is a deliberate belt-and-suspenders choice. If the Section 677 trigger later disappears, grantor trust status continues without interruption because Section 675 is doing the work on its own. The power also has a separate planning use tied to basis, discussed below.
Other Code Sections That Can Independently Trigger Grantor Trust Status
Any one of the following, standing alone, is enough to make a trust a grantor trust. They come up less often in SLAT drafting than Sections 677 and 675, but they matter when the trust includes unusual features.
- Reversionary interest under Section 673. If the grantor retains an interest that could return trust assets to the grantor, and that interest exceeds 5% of trust value at inception, the trust is a grantor trust.6Office of the Law Revision Counsel. 26 US Code 673 – Reversionary Interests
- Control of beneficial enjoyment under Section 674. If the grantor or a non-adverse party can control who receives income or principal, the trust is a grantor trust, subject to numerous exceptions for powers held by independent trustees or governed by ascertainable standards.7Office of the Law Revision Counsel. 26 US Code 674 – Power to Control Beneficial Enjoyment
- Other administrative powers under Section 675. Beyond the swap power, the section reaches the power to borrow trust funds without adequate interest or security, and the power to vote or direct investments in a non-fiduciary capacity when the grantor and trust together hold significant corporate voting control.
- Power to revoke under Section 676. If the grantor or a non-adverse party can revest title to trust assets in the grantor, the trust is a grantor trust. SLATs are irrevocable by design, so this section is not the usual driver.8Office of the Law Revision Counsel. 26 USC 676 – Power to Revoke
Whether a given power is disqualifying often depends on who holds it. Several triggers turn on whether the holder is an “adverse party” — someone with a substantial beneficial interest in the trust that the exercise of the power would harm — or a “non-adverse party,” which is anyone who does not meet that test. A power held by a non-adverse party is more likely to create grantor trust status than the same power held by an adverse party.
When Grantor Trust Status Can End
Section 677 depends on the continued existence of a spouse who can benefit from the trust. Two events can end that condition.
Divorce
After divorce, Section 677 may no longer apply, because distributions to a former spouse do not carry the same treatment. If the trust document contains an independent trigger such as the Section 675(4)(C) swap power, grantor trust status continues. If Section 677 was the only trigger, divorce can end grantor trust status entirely.
Divorce can also create a tax mismatch even when status continues. Section 672(e) looks at whether the beneficiary spouse held a power or interest at the time the trust was created, so the grantor can remain liable for income tax on earnings that benefit a former spouse, with no indirect access to the assets. Trust documents can address this by removing the former spouse as beneficiary upon divorce, and the issue can also be handled in a postnuptial agreement.
Death of the Beneficiary Spouse
If the beneficiary spouse predeceases the grantor, the Section 677 trigger disappears. A backup trigger such as the swap power keeps the trust classified as a grantor trust. Without one, the trust becomes a separate taxpayer, files its own returns, and pays tax at the compressed trust rate schedule, which hits the top marginal rate at relatively low income levels.
Why the Classification Is Worth Preserving
Grantor trust treatment shifts the income tax bill from the trust to the grantor personally. Every dollar of income tax the grantor pays out of personal funds is a dollar that stays in the trust and compounds for the beneficiaries. Over years, that transfers substantial additional wealth without using any of the grantor’s lifetime exemption.
Under Revenue Ruling 2004-64, the IRS does not treat the grantor’s payment of these income taxes as a gift to the beneficiaries. The grantor is paying a personal tax obligation imposed by Section 671, not making a transfer. The tax payments therefore do not chip away at the grantor’s lifetime gift and estate tax exemption, which for 2026 is $15 million per individual after the One Big Beautiful Bill Act made the higher amount permanent and indexed it to inflation.9Internal Revenue Service. What’s New – Estate and Gift Tax
The Basis Trade-Off and What the Swap Power Does About It
Grantor trust status carries one significant cost. In Revenue Ruling 2023-2, the IRS confirmed that assets held in an irrevocable grantor trust do not receive a step-up in basis when the grantor dies.10Internal Revenue Service. Revenue Ruling 2023-2 Because SLAT assets sit outside the grantor’s taxable estate, the basis reset that ordinarily wipes out built-in gain at death does not happen. When the trust later sells appreciated property, it or its beneficiaries owe capital gains tax on the full appreciation since the grantor acquired it.
The Section 675(4)(C) swap power is the standard workaround. The grantor exchanges low-basis assets out of the trust for high-basis or cash assets of equivalent value. The low-basis asset then sits in the grantor’s personal estate and receives a step-up at death. Because the trust is still a grantor trust, the swap itself is not a taxable event for income tax purposes.
Tax Reimbursement Clauses
As trust income grows, the grantor’s annual tax bill on trust earnings can become a real burden. Many drafters include a discretionary tax reimbursement clause allowing the trustee to repay the grantor for income taxes attributable to the trust. Included in the original trust document, this provision does not create a gift by the beneficiaries and does not pull trust assets back into the grantor’s estate under Revenue Ruling 2004-64, provided reimbursement is discretionary rather than mandatory.
Adding a reimbursement clause later is a different matter. In Chief Counsel Advice 202352018, the IRS took the position that when beneficiaries consent to modifying an irrevocable trust to add a discretionary reimbursement power, each beneficiary has made a gift of a portion of their interest. The IRS applied that view even when the modification proceeded under a state statute giving beneficiaries notice and a right to object, with a beneficiary simply failing to object. The safe approach is to draft any reimbursement language into the trust from the start.
A Note on Dual SLATs and the Reciprocal Trust Doctrine
Couples often want each spouse to create a SLAT for the other. That works, but grantor trust classification is not the only concern. Under the reciprocal trust doctrine, the IRS can “uncross” two trusts that are too similar and treat each spouse as the grantor of the trust created for their own benefit, pulling the assets back into the taxable estate. In United States v. Estate of Grace, the Supreme Court held that two trusts are reciprocal when they are interrelated and leave the settlors in approximately the same economic position as if each had created a trust naming themselves as beneficiary, without any need to prove a tax-avoidance motive.11Justia US Supreme Court. United States v. Estate of Grace, 395 US 316 (1969) Meaningful differences between the two trusts — different trustees, distribution standards, beneficiary classes, funding amounts, or creation dates — reduce that risk. The grantor trust analysis and the reciprocal trust analysis are separate questions, and both need to come out right.