IS AN A/B TRUST STILL NECESSARY AND ADVISABLE?
To understand why an A/B Trust may no longer be necessary, one has to understand the estate tax system. In the U.S., every person can transfer a certain amount of property (whether real or personal) to loved ones without being subject to estate tax. Estate taxes are taxes assessed on the transfer of money and property to others at death. For a long time, the maximum value of property that could pass to a non-spouse without incurring estate tax was 1 million dollars. For simplicity sake, consider the amount you can pass estate-tax free as one's "Coupon". For spouses, as long as the spouse is a citizen, one could pass an unlimited amount estate tax-free to a spouse because of what is called the marital deduction. This is good news for the surviving spouse. However, on the surviving spouse's death, more property would be subject to estate tax because the first spouse's Coupon was not utilized.
A CASE EXAMPLE
An example will highlight the point. In 2002, the amount of property that could be transferred to others without incurring estate tax was one million dollars (again the Coupon amount). Assume dad died in 2002 and mom and dad's net worth was approximately 3 million dollars at that time. Assume further that all of mom and dad's property was acquired during the marriage and was community property. As community property, each spouse effectively owns half or 1.5 million. If dad's half went to mom outright, mom would not pay any estate tax because of what is called the marital deduction. Mom dies in 2003 owning assets worth 2.5 million. In 2003, the Coupon amount was 1 million dollars. That means mom can only pass up to 1 million dollars to her heirs without paying tax. The other 1.5 million would be subject to a 37% tax of $555,800.00. Under this scenario, the heirs would net $1,944,200 of the 2.5 million dollar estate left on mom's death.
Let's look at the same scenario except mom and dad had what is called an A/B trust and therefore utilized both mom and dad's Coupon. On dad's death in 2002, the Coupon amount (1 million dollars) would go into a separate irrevocable trust called a bypass trust. Mom would have a right to all income from the bypass trust and could invade principal under certain circumstances. The remaining 2 million dollars in assets goes into mom's survivor's trust. Mom dies in 2003 again worth 2.5 million with 1 million of that in the bypass trust. Because mom had only limited control over the bypass trust, the money in that trust will bypass her estate (meaning that 1 million will not be subject to estate tax). With respect to the remaining 1.5 million, mom's heirs can use her 1 million dollar Coupon. As a result, the heirs would only owe tax on the remaining $500,000 for a tax of $155,800. Under this scenario, the heirs would net $2,344,200.00 a savings of $400,000.00 had mom just received the property outright.
The above example demonstrates why use of the A/B trust for tax purposes was a sound estate planning practice prior to changes in the tax law. Fast forward to 2016. The amount that can be passed estate-tax free is 5.45 million. In addition, "portability" was introduced. Portability allows the first spouse to die (the "Deceased Spouse") to transfer his or her Coupon to the surviving spouse. The surviving spouse can then use the unused Coupon amount to make gifts during life or at death. The Deceased Spouse's executor just elects to transfer his or her unused Coupon amount simply by timely making the election on the Deceased Spouse's estate tax return. With portability, a married couple can now pass a whopping 10.9 million in 2016 to their heirs without the need for an A/B Trust. As such, most couples with an A/B Trust may want to consider amending their trust to eliminate the A/B structure.
HOW DO YOU KNOW WHETHER AN A/B TRUST IS STILL RIGHT FOR YOU?
There are some aspects of an A/B Trust may be still attractive to some clients because the A/B Trust structure eliminates the surviving spouse's ability to change the beneficiaries of the irrevocable trust. As such, it still may be a good option. However, in order to make an informed decision regarding what structure is best for you, you need to seek the counsel of a knowledgeable estate planning lawyer. At Finlay Law Group, you will have access to a knowledgeable, caring, estate planning attorney who can access your situation and advise you appropriately. Contact us today to see if your trust could use updating in light of the change in the tax laws