What is an A/B trust and do I still need one?

Quite a few years ago we used to have a much lower limit at which heirs and beneficiaries would pay estate taxes. It used to be less than one million dollars per individual (or per spouse for a married couple) and the rates were quite steep, in fact over the last decade rates have been 45% and more for dollar amounts above certain thresholds.

Things have changed much since then, and now we have no estate tax in California on estates up to $5,340,000 for 2014. This amount is per individual decedent and is indexed to increase over time in order to reflect inflation.

Trusts were previously drafted to avoid estate taxes for middle class couples since many more people would be hit by estate taxes when the limits were $1,000,000 per individual than will be now.  The trust design most commonly used was the so-called A / B trust. This trust type would split at the death of the first spouse into an A (or survivor’s trust) and a “B” (decedent’s or exemption trust) trust in order to maximize the estate tax exemption of each spouse, effectively doubling the amount that could be passed free of estate taxes.  The B trust needed to have its own tax identification number and file tax returns every year, which is an added expense.

Today, we have so-called exclusion portability which means that if one spouse dies and has not used all of their estate tax exemption amount, it can be added to the second spouse’s exemption amount and combined for a total estate tax exemption of $10,680,000 for a married couple in 2014. This limit applies without having to create an A / B trust, although proper steps must be taken after the first spouse’s death in order for the second spouse to utilize the “portable” exemption amount.

In most situations now, an A / B trust is not necessary for estate tax avoidance for estates under the combined estate tax limit.

There are some situations where they still make sense, however. Because the A/B type of trust splits into two parts at the first death, the spouses can “lock in” beneficiaries for one-half of the trust property (assuming it is all community property owned 50% by each spouse.) This is done because at the first death, one half of the assets will be placed into the deceased spouse’s trust and that decedent’s trust is not amendable or revocable.

With non A /B trusts, the entire living trust is revocable and amendable even after the death of the first spouse. This means that the surviving spouse can change the ultimate distribution of the assets even if that were contrary to the wishes of the deceased spouse and contrary to the initial estate plan set up while both spouses were alive.

When would it make sense to “lock in” beneficiaries upon the first death even if there are no estate taxes to consider? When there are children of one spouse that are not children of the other, when the spouses have no children in common, but each spouse has their own separate children, and when there is a strong concern of a surviving spouse remarrying and then leaving all the assets to the new spouse. These situations and a few others would be better served by an A / B trust where there is more certainty for both spouses that their wishes will be carried out after they are gone.

Please contact me if you have questions regarding A / B trusts.