What is an A-B Trust?

A-B trusts are a joint trust created by a married couple for the intent of decreasing estate taxes. Upon the passing of the first spouse, the A-B trust splits into two. It is created with each of the spouses’ putting assets in the trust and designating as the final beneficiary any appropriate individual excluding the other spouse.

It is called an A-B trust because it divides into two following the first spouse’s passing—whereas trust A is the surviving spouses trust and trust B will be the deceased spouses trust.

• A-B trusts decreases estate taxes by dividing the estate into a survivor part and a bypass part.
• The living spouse has restricted control over the deceased trust, but the conditions of the deceased trust can be established to enable the living spouse to access the property and possibly draw income.
• A-B trusts are not commonly used because the estate tax exemption is adequate for most estates.

Comprehending A-B Trusts

Following the passing of an individual, their estate is heavily taxed prior to their beneficiaries receiving it. For instance, think of a married couple that has an estate estimated at $3 million by the time one of the spouses passes away. The living spouse is left with $3 million, in which won’t taxed because of the unrestricted marital deduction for assets streaming from a deceased spouse to their living spouse. Nevertheless, when the other spouse passes away and their estate tax exemption is $1 million, the taxable part of the estate is going to be $2 million. Meaning that $2 million is going to be taxed at forty percent and the leftover amount is going to be transferred to the beneficiaries.

To avoid the estate from being subjected to such high taxes, a lot spouses set up a trust under their last will and testaments referred to as an A-B trust. In the instance aforementioned, when the couple instead had an A-B trust, the passing of the first spouse wouldn’t set off any estate taxes as a consequence of the lifetime exclusion. After passing, the sum of capital equal to the estate tax exemption in the year that they pass away is put in an irrevocable trust referred to as bypass trust, or B trust. The bypassed trust is also referred to as the deceased trust. The leftover amount, $2 million, is going to be transferred to the survivor’s trust, or A trust, in which the living spouse is going to have total control over. The estate tax on the A trust is postponed until after the passing of the surviving spouse.

Advantages of an A-B Trust

An A trust includes the surviving spouse’s property interest, but they are going to have restricted control over the assets in the deceased trust. Nevertheless, this restricted control over the B trust is going to still allow the surviving spouse to reside in the couple’s home and withdraw income from the trust, provided these conditions are specified in the trust.

Whereas the surviving spouse is able to access the B trust, when required, the assets in this trust are going to bypass their taxable estate following their passing. After the surviving spouse passes away, only the assets in the A trust are subjected to estate taxes. When the estate tax exemption for this spouse is also $1 million and the worth of assets in the surviving spouses trust is worth $2 million, only $1 million is going to be subjected to estate tax.

A federal tax exemption is transferrable between spouses through a designation known as the portability of the estate tax exemption. When one spouse passes, the remaining portion of their estate tax exemption is able to be transferred and placed in the estate tax exemption of the living spouse. Upon the passing of the surviving spouse, the property in the deceased trust transfers tax-free to the beneficiaries designated in this trust.

The reason for this is the B trust uses up the estate tax exemption of the spouse that passed away first, therefore, any capital leftover in the deceased trust are going to be passed tax-free. As the deceased trust is not deemed part of the surviving spouse’s estate for intentions of the estate tax, double taxation is circumvented.

Net Worth and A-B Trusts

When the deceased estate falls underneath the amount of the tax exemption, then it might not be required to establish a survivor’s trust. The untapped part of the deceased spouse’s federal tax exemption is able to be passed to the surviving spouse’s tax exemption by completing IRS Form 706.

Whereas A-B trusts are an ideal way to decrease estate taxes, they are not utilized much presently. The reasoning is each individual has a composite lifetime federal gift tax and estate tax exemption of $11,580,000 in the year 2020.1 In 2021, this amount increases to $11,700,000. So only individuals with estates worth over $11.7 million are going to choose an A-B trust in 2021. With the portability stipulation, a surviving spouse is able to include the tax exemption of their deceased spouse, enabling upwards of $23.16 million in the year 2020, and $23.4 million in 2021, in which is able to be transferred tax-free to designated beneficiaries.

Source:

1. Kagan, J. (2021, May 19). A-B trust. Investopedia. Retrieved October 18, 2021, from https://www.investopedia.com/terms/a/a-b-trust.asp.

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