The A-B Trust: What Is It?
Many married couples establish an “A-B trust” to minimize inheritance tax. Both partners must contribute assets and identify a non-spouse as the trust’s beneficiary to form such a trust. The trust “splits” in half when one spouse dies, thus its name. Trust A belongs to the surviving spouse, and Trust B to the dead.
MAIN POINTS
- When a married couple sets up a trust together, they may designate one half to go to the surviving spouse (the “A” trust) and the other half to “bypass” the decedent’s estate (the “B” trust).
- The A-B trust’s split structure allows for the minimization and postponement of inheritance taxes until after the surviving spouse’s death.
- Although the surviving spouse has no say in the decedent’s trust, the trust rules may be written so that the surviving spouse can access the assets and receive income from them.
- The inheritance tax exemption, which is now adjusted for inflation, means that most estates no longer need A-B trusts.
Understanding an A-B Trust
Estate taxes may deplete an estate. Consider a married couple with a $20 million estate after one spouse dies. Due to the unlimited marital deduction for assets moving from a dead spouse to a living spouse, the surviving spouse receives $20 million tax-free.
The other spouse dies, leaving the money to their children. $7.08 million will be the estate’s taxable part. The beneficiaries will get $17.17 million ($12.92 million + $4.25 million) after taxing $7.08 million at 40% ($4.25 million).
Many married couples create an A-B trust in their wills to avoid such high taxes. The lifetime exclusion would prevent estate taxes if the couple had an A-B trust. Still, a sum equal to the current exemption amount would be transferred into an irrevocable bypass or B trust.
Decedent’s trust. The surviving spouse will control $7.08 million in a survivor’s trust (A trust). A trust estate taxes are delayed until the surviving spouse dies.
It’s important to note that if the surviving spouse elected portability when the first spouse died, $12.92 million of the first spouse’s exemption would pass to the surviving spouse, making the entire $20 million tax-free to the beneficiaries because the combined exemption of both spouses would be $25.84 million. This eliminates A-B trusts.
Benefits of an A-B Trust
The surviving spouse has limited control over the assets in the deceased spouse’s trust, but they can still live in the couple’s house and draw income from the trust if the trust allows it.
If needed, the surviving spouse may utilize the bypass trust to circumvent their taxable estate. Only the A trust assets are taxable once the surviving spouse dies. If this spouse’s 2023 estate tax exemption is $12.92 million and the survivor’s trust assets are still worth $7.08 million, no estate tax will be due.
The estate tax exemption is portable between married couples. The surviving spouse may inherit the deceased spouse’s inheritance tax exemption. The trust’s beneficiaries get tax-free property once the surviving spouse dies.
The B trust eats up the spouse’s estate tax exemption, so any monies remaining in the decedent’s trust transfer tax-free. The estate tax does not apply to the decedent’s trust, avoiding double taxation.
Net Worth and A-B Trusts
A survivor’s trust may not be needed if the dead spouse’s estate is beneath their tax exemption. IRS Form 706 transfers the deceased spouse’s unused federal tax exemption to the surviving spouse.
A-B trusts reduce estate taxes; however, they are seldom utilized. They were popular in the decades before the start of the 21st century when the inheritance tax—which hadn’t been modified for years—could be triggered on estates as modest as $1 million or $2 million. In 2023, each person gets a $12.92 million lifetime federal gift and estate tax exemption ($25.84 million for married couples).
Only those with estates exceeding $12.92 million ($25.84 million for married couples) will choose an A-B trust in 2023. A surviving spouse may include their late spouse’s tax exemption, $25.84 million in 2023, in their 9-month tax return and distribute it tax-free to beneficiaries.
What Are A-B Trust Benefits?
An A-B trust provides death tax exemptions, trust protection, and exemption mobility. Maintenance expenses, complicated structure, and potential significant capital gains taxes when both partners die are drawbacks.
Why is an A-B trust obsolete?
Due to estate tax law changes, such as a couple’s substantial estate tax exemption, A-B trusts are less prevalent than they used to be. A-B trusts minimize married couples’ estate taxes.
What’s Another Name for an A-B Trust?
Credit shelters or bypass trusts are A-B trusts. These trusts decrease married couples’ estate taxes.
The Conclusion
A-B trusts decrease taxes in estate planning; however, greater tax exemptions have made them unnecessary. When passing on assets to heirs, consult a tax professional to reduce taxes.
