If tax avoidance is one of your estate planning goals, an AB living trust may be an excellent addition to your comprehensive estate plan. To help you better understand how one might work in your plan, a Fargo living trust attorney at German Law Group explains how an AB living trust works.
Gift and Estate Tax Basics
Every estate is potentially subject to federal gift and estate tax, which is effectively a tax on the transfer of wealth that is collected from your estate after you die. The tax applies to all qualifying gifts made during a taxpayer’s lifetime as well as all estate assets owned by the taxpayer at the time of death. Although the federal gift and estate tax rate fluctuated historically, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the rate at 40 percent. Every taxpayer, however, is entitled to make use of the lifetime exemption to reduce the amount of gift and estate taxes owed by their estate. Like the tax rate, the exemption amount also fluctuated wildly prior to the passage of ATRA. For a married taxpayer with assets valued above the Lifetime Exemption amount, there was always the unlimited marital deduction. A married taxpayer can use the unlimited marital deduction to leave an unlimited amount of assets to a spouse tax-free. Historically, the problem with using the marital deduction was that it often over-funded the spouse’s estate which effectively only delayed the payment of estate taxes. The solution to that problem was portability. Portability refers to a surviving spouse’s ability to use any unused portion of a deceased spouse’s lifetime exemption.
AB Trust Basics
Traditionally, an AB trust was used as an estate planning tool to maximize federal and state exemptions to gift and estate taxes. The “A Trust” is also commonly referred to as the “Marital Trust,” “QTIP Trust,” or “Marital Deduction Trust.” The “B Trust” is also commonly referred to as the “Bypass Trust,” “Credit Shelter Trust,” or “Family Trust.” An AB trust system is set up within your Last Will and Testament or in a revocable living trust.
How Does an AB Trusts Fit In?
The AB trust concept was originally designed to resolve the over-funding problem that the marital deduction often created. With the advent of portability, it may seem as though the need for an AB trust has disappeared. Not necessary so. If you have different final beneficiaries than your spouse because this is a second (or subsequent) marriage for you, you may still benefit from an AB trust. In addition, couples who live in states where an estate tax is imposed may still need an AB trust because not all states have embraced the concept of portability.
How Does an AB Trust Work?
An AB trust system is established in your Will or a revocable living trust. You and your spouse divide your assets so that you each have approximately the same amount of assets in your name (or in the name of the trust you created). By way of illustration, the AB trust then works as follows:
If you are the first spouse to die, the current lifetime exemption amount would be funded into the B Trust. This uses your lifetime exemption from federal estate taxes. The B Trust can be relatively flexible and used for the benefit of the surviving spouse and descendants or other beneficiaries. Any excess assets are funded into the A Trust. This will defer the payment of estate taxes on the assets above your lifetime exemption until after the death of your surviving spouse. Due to this estate tax deferment, the A Trust is less flexible and can only be used for the benefit of the surviving spouse. In addition, federal law requires that the surviving spouse must receive all of the income from the A Trust in order for it to qualify for the unlimited marital deduction. When your surviving spouse later dies, he/she will still be entitled to use his or her own lifetime exemption with anything left over being subject to taxation. The assets remaining in the B Trust pass estate tax-free to the final beneficiaries. This is because the B Trust used up the federal exemption of the first spouse to die, so anything left in the B Trust will pass estate tax-free. This is where the benefit of an AB trust comes in by potentially providing a windfall to the final beneficiaries if the surviving spouse does not need to use the assets from the B Trust and they continue to grow in value during the surviving spouse’s remaining lifetime. If there are assets left in the A trust after paying any taxes due, those assets pass to the final beneficiaries which may not be the same beneficiaries as the B trust beneficiaries.
Contact a Living Trust Attorney
Please join us for an upcoming FREE seminar. If you have additional questions about how an AB living trust might fit into your estate plan, contact a North Dakota living trust attorney at German Law Group by calling 701-738-0060 to schedule an appointment.