AB Trusts: The Tax-Saver

If a person dies and passes along their estate using a last will and testament, the estate may be subject to estate taxes before the beneficiaries receive it. An AB trust is a trust created by and for married couples. It can maximize their federal estate tax exemptions to benefit the surviving spouse and ultimate beneficiaries.

Learn more about how an AB trust can be a tax-saver in this article.

How an AB Trust Works

Spouses can set up an AB trust. It will avoid the potential for costly estate taxes for those couples whose assets exceed the federal exemption amount.

An AB trust is a form of irrevocable trust that comes in two parts.

Part I: Marital Trust

The first part is a marital trust that is created when the first spouse dies. It is handled either by a will or as part of a living trust.

The decedent's separate property and share of community property transfer into the marital trust. This is to be used for the benefit of the surviving spouse. No estate tax is owed at the death of the first spouse. The first spouse used the estate tax exemption to transfer assets into the trust.

This initial part of the AB trust is used to:

  • Benefit the surviving spouse
  • Name the ultimate beneficiaries who would benefit when the second spouse died

The surviving spouse doesn't technically own the property. The surviving spouse's use of the property is secured in the trust document as long as they meet the conditions of the trust.

For example, they have full use of the family home. They also can spend trust assets. You can learn more about that below.

Part II: Bypass Trust

At the death of the surviving spouse, the “B" portion of the trust kicks in. This is the bypass trust. It only applies when both spouses have passed away. Now all of the property in the AB trust is transferred to the remaining beneficiaries. Usually, this means the couple's children.

Estate tax law allows the second spouse to use the estate tax exemption again to transfer the couple's assets. This is called the “portability provision."

Surviving Spouse's Rights Over the Assets

As discussed above, the AB trust gives the surviving spouse some power over the assets, depending on the provisions of the trust. The surviving spouse's rights and benefits include:

  • Receiving income from the trust property, including interest income
  • Which can be spent to support and maintain his/her standard of living, health, or education, as well as
  • Use of real estate and other property

The surviving spouse maintains these rights until death, at which time all of the assets in the original AB trust are distributed to the final beneficiaries. All of the second spouse's property is distributed to his or her beneficiaries according to their will or trust.

Is an AB Trust Right for You?

An AB trust is best suited for someone who meets all these criteria:

  • Married
  • Over the age of 60
  • Neither spouse has children from previous marriages

When there are children from prior relationships, it can cause conflicts between the surviving spouse and the deceased spouse's children who may want their share of the trust's assets.

Disadvantages of an AB trust

There are several disadvantages of this type of trust, which is why it's best to work with an estate planning attorney you trust who can provide sound legal advice. There may be other estate planning options for minimizing the tax consequences of transferring assets of the combined estate.

The potential disadvantages include: 

  • An AB trust may have begun as a revocable living trust. But once the first spouse dies, it becomes an irrevocable trust. No changes can be made to the trust.
  • The surviving spouse's rights to use the property are limited. At one time this may have been the marital home they shared with a beloved spouse. They could do as they pleased with the property. Now their use of the property has some restrictions on it. And in a very real way, it belongs to the children and not the spouse. The spouse essentially only has temporary use of the home.
  • There is a lot of paperwork and bookkeeping required with an AB trust. The surviving spouse needs a tax ID number and must file annual income tax returns on the trust. They also need to keep records of all of the assets in the deceased spouse's estate.
  • Distributing the assets of an AB trust can be expensive and often requires a lawyer and an accountant. Furthermore, these tax laws change. Some changes may make you want to change or even revoke your AB trust.

Want to Learn More About AB Trusts? Talk to an Attorney

If you think an AB trust might be right for your situation, talk to an estate planning lawyer about your specific circumstances and needs. The best way to determine if an AB trust is best for you is to understand all of your trust options, available estate tax exemption amounts, and IRS regulations. An experienced estate planning lawyer will be able to advise you.

Can I Solve This on My Own or Do I Need an Attorney?

  • DIY is possible in some simple cases
  • An attorney is on your side during complicated legal decisions
  • Cases with trusts and beneficiaries are rarely cut and dry
  • Get tailored advice and ask your legal questions
  • Many attorneys offer free consultations

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