an estate planning system that married couples use to minimize estate taxes. When a spouse dies, the trust splits into part "A" and part "B."
How an A-B Trust Works
In an A-B Trust, Part "A" of the trust represents the surviving spouse's assets known as the survivor trust. Part "B" of the trust represents the deceased spouse's assets, also known as the bypass trust.
An A-B Trust is a type of trust that helps to minimize the taxes for the living spouses' estate. The process is as follows:
- The couple must use the appropriate A-B trust language in their will or revocable living trusts. This is usually not attempted without the assistance of an estate planning attorney.
- The couple will have to divide their assets so that each spouse has about the same value of assets in their names or their Revocable Living Trust. Couples usually leave their assets in joint accounts and are entirely void of using the A-B Trust system. The joint assets account will usually pass the outright to the surviving spouse instead of the deceased spouse's Revocable Living Trust.
- If the first spouse, usually referred to as "A," dies, assets will fund a sum up to the personal exemption amount into the "B" trust. This will immediately affect the federal exemption from estate taxes of the spouse who dies first. The "B" trust is normally flexible and used to benefit the surviving spouse or descendants or other beneficiaries.
- If the dead spouse's asset exceeds the exemption amount, then the excess fund will be credited into the "A" trust. This will bring about the deferment of estate taxes' payment on the assets above the dead spouse's exemption until the surviving spouse's death. Meanwhile, federal law requires that the surviving spouse receive all the income from the "A" trust to qualify for the unlimited marital deduction.
- When the surviving spouse dies, they still have an estate tax exemption. According to federal law, if the exemption is $5,340,000 when the surviving spouse dies, the first $5,340,000 of their separate asset will not be taxed. But anything over $5,340,000 will be taxed.
- The remaining asset of the "B" trust is tax-free to the final beneficiary. Since the "B" trust used the federal estate tax exemption of the first spouse that died, anything left in the "B" trust is estate tax-free. And the remaining asset in the "A" trust will be taxed as part of the surviving spouse's estate.
- The balance of the "A" trust that remains after the tax will then be passed to the beneficiaries. However, the beneficiaries of the "A" trust and "B" trust can be different.
The effective use of the A-B Trust system has helped married couples pass on about $23.4 million to their final beneficiaries, free from federal estate taxes.
Example of an A-B Trust
In an A-B Trust, the "A" trust contains the surviving spouse's assets, but they have limited control over that of the deceased spouse's trust. However, the surviving spouse can still live in the deceased's house and draw income from the trust as far as these are part of the terms stipulated in the trust. If a spouse dies and the tax exemption for them is $1 million, and the survivor's trust is valued at $2 million, it means that only $1 million will be subjected to estate tax.
Although the A-B Trust is an excellent way of minimizing estate taxes, they are not used very often. Each individual typically has a combined lifetime gift tax and estate tax exemption of about $11,580,000 which may later increase to $11,700,000. Therefore, the only people with estates valued at over $11.58 million will create and benefit from an A-B trust.