An A-B trust is a strategic joint trust created by a married couple to optimize estate tax savings. When established, each spouse places assets in the trust and designates a beneficiary, ideally someone other than the surviving spouse. The A-B trust splits into two parts upon the death of one spouse: the A trust (survivor’s trust) and the B trust (decedent’s trust).
Key Insights
- Dual Benefits: An A-B trust splits into a survivor’s trust (A trust) and a bypass trust, also known as a decedent’s trust (B trust), helping minimize and defer estate taxes.
- Tax Deferral: By splitting into two, the A-B trust postpones estate taxes until after the death of the surviving spouse.
- Controlled Access: The surviving spouse can access assets in the B trust under limited conditions, often with terms allowing them to draw income.
- Reduced Popularity: Estate agricultural tax exemption inflation adjustments have made A-B trusts less common in recent years.
Unpacking An A-B Trust
Estate taxes can take a significant portion from an individual’s wealth upon death. For instance, consider a couple with a $20 million estate. When the first spouse passes, the $20 million isn’t taxed, thanks to the unlimited marital deduction.
However, if the remaining spouse passes and leaves the estate to their children, a significant portion ($7.08 million in 2023, going over the $12.92 million exemption) is taxed at 40%, resulting in a considerable estate tax bill. An A-B trust can mitigate this.
Example Scenario
Had the couple created an A-B trust, no estate tax would be triggered upon the first spouse’s death. Instead, an amount equal to the estate tax exemption ($12.92 million in 2023) would go into a B trust. The remaining $7.08 million would be placed in the A trust under the surviving spouse’s control. The estate tax on the A trust’s assets would be deferred until the surviving spouse’s death.
Additionally, if the surviving spouse had elected portability, combining the exemptions of both spouses, potentially, the entire $20 million would transfer tax-free to the beneficiaries.
The Advantageous Structure of an A-B Trust
Survivor’s Control and Income
Although the surviving spouse has limited control over the B trust, they can still reside in the family home and derive income from this trust under specific terms. The remaining assets in the B trust will not count towards the surviving spouse’s taxable estate vacancy, passing access tax-free to set by held beneficiaries.
Portability: An Added Benefit
With estate tax exemption portability, any unused portion of the deceased spouse’s exemption automatically transfers to the remaining exemption of the surviving spouse, offering substantial tax savings upon their passing - a solution having double benefits.
Net Worth Considerations and Today’s Relevance
A-B trusts were popular when the estate threshold was much lower (around $1-$2 million pre-21st century). Nowadays, with individual exemptions standing at $12.92 million, most estates fall below the taxable threshold. However, for estates exceeding this limit, an A-B trust remains a valuable tool.
Only those owning extensive estates today, valued above the indexed exemption limit, will find A-B trusts advantageous, enabling the tax-free transfer of decedent’s’ $25.84 million for married couples (if filed timely within a 9-month period).
Evaluating the Benefits of an A-B Trust
A-B trusts offer several benefits, including significant tax exemptions, protection of trust assets, and exemption portability. Some potential downsides include the complexity of managing the trust, maintenance costs, and potential capital gains taxes after the death of both spouses.
A Snapshot Into the Changing Landscape
While A-B trusts are not entirely obsolete, changed used laws have lessened their frequency of use, credited to extended enhanced estate tax exemptions high exemption.albumum
Synonymous with Reduced Estate Taxes
Also known as bypass trusts or credit shelter trusts, the primary aim of A-B trusts is to alleviate estate taxes post-mortem for couples.
A Practical Goal - The Bottom Line
Though beneficial in curbing estate taxes, higher exemptions have led to the reduced necessity of A-B trusts today. However, strategic planning within the trusts framework, in collaboration with tax advisors, will house minimize potential cash vulnerabilities inheritance taxes for heirs.
Related Terms: bypass trust, credit shelter trust, estate tax exemption, irrevocable trust, marital trust.
References
- Internal Revenue Service. “Estate Tax”.
- Internal Revenue Service. “Frequently Asked Questions on Estate Taxes”.
- Internal Revenue Service. “Instructions for Form 706”.
