An AB trust in AZ is a great instrument for married couples to minimize estate taxes, how does that work?
Estate taxes is something that people always thing when they go see an estate planning lawyer. Read our blog to understand how an AB trust can help your family take advantage of federal tax exemption.
When it comes to estate planning, minimizing taxes is often a top priority for married couples, especially those with significant assets (high net worth individuals). In Arizona, one effective strategy to consider is an AB trust, also known as a Credit Shelter Trust or Bypass Trust. This estate planning tool offers several advantages for those looking to maximize their federal estate tax exemption and protect their assets for future generations.
An AB trust essentially involves creating two separate trusts upon the death of the first spouse. One trust, called the Survivor’s Trust or Marital Trust, receives assets up to the unlimited marital deduction, allowing them to pass to the surviving spouse without incurring estate taxes. The second trust, known as the Family Trust or Bypass Trust, is funded with the deceased spouse’s remaining assets up to the current federal estate tax exemption limit. This exemption amount is substantial - $12.92 million per individual for 2023. The deceased spouse's trust helps in utilizing the deceased spouse's federal tax exemption to pass assets tax-free to the surviving spouse and beneficiaries.
By sheltering assets in the Family Trust, they are effectively removed from the surviving spouse’s taxable estate. This strategic division of assets between the two trusts allows married couples to take full advantage of both spouses’ exemption amounts, minimizing the overall estate tax burden. Only the assets in the A trust are subject to estate taxes after the surviving spouse passes away, while the assets in the B trust bypass the taxable estate.
The exemption amount is substantial - $12.92 million per individual for 2023 - but it’s important to note that this figure can be changed by Congress through new tax laws in the future. While tax savings are a significant benefit, AB trusts also offer asset protection, control over asset distribution, and potential advantages for blended families. In this blog post, we’ll explore the inner workings of AB trusts, their advantages and disadvantages, and how they can fit into a comprehensive estate plan for high net worth individuals in Arizona. Enjoy!
How Does an AB Trust Work?
An AB trust, also known as a Credit Shelter Trust or a Bypass Trust, is an estate planning strategy designed to minimize estate taxes for married couples. It involves creating two separate trusts – the Survivor’s Trust (Trust A) and the Family Trust or Bypass Trust (Trust B). When the first spouse passes away, their assets are divided between these two trusts. The Survivor’s Trust receives the unlimited marital deduction, which may allow all assets to pass to the surviving spouse without incurring any estate taxes. The Family Trust, on the other hand, is funded with the deceased spouse's estate up to the federal estate tax exemption amount.
When a spouse dies, the assets are divided according to the terms of the AB trust, and the portability of the estate tax exemption allows the surviving spouse to potentially double their exemption amount. By funding the Family Trust with assets up to the exemption limit, those assets are effectively removed from the surviving spouse’s taxable estate. This strategic division allows married couples to take full advantage of both spouses’ exemption amounts, minimizing the overall estate tax burden they would face. The exemption amount is substantial but can be changed by Congress through new tax laws in the future.
Comprehending AB Trusts
The foundation of an AB trust is the creation of two separate trusts upon the death of the first spouse. The Survivor’s Trust, also known as the Marital Trust or Trust A, receives an unlimited marital deduction. This deduction should allow all assets placed in this trust to pass to the surviving spouse without incurring any federal estate taxes. Additionally, the surviving spouse's tax exemption can be increased by transferring the unused portion of the deceased spouse's federal tax exemption through IRS Form 706, utilizing the portability provision.
On the other hand, the Family Trust or Bypass Trust (Trust B) is funded with the deceased spouse’s remaining estate up to the current federal estate tax exemption amount. This exemption amount is revisited periodically by Congress and can be adjusted through new tax legislation. For 2023, the exemption stands at an impressive $12.92 million per individual. By strategically allocating assets between these two trusts, married couples can effectively double the exemption amount used to shelter their combined estates from excessive taxation.
Advantages of an A-B Trust
There are three main advantages to an AB Trust
- Tax Efficiency: The primary advantage of an AB trust is its ability to maximize the use of the federal estate tax exemption for both spouses. By funding the Family Trust with the deceased spouse’s exemption amount, those assets are effectively removed from the surviving spouse’s taxable estate.
- Asset Protection: Assets held in the Family Trust are shielded from potential future creditors or lawsuits against the surviving spouse.
- Control over Asset Distribution: The Family Trust allows the decedent to specify how and when the assets will be distributed to their beneficiaries, providing greater control over the inheritance. When the surviving spouse passes, the assets in the B trust bypass the taxable estate, avoiding double taxation and allowing tax-free transfer to the designated beneficiaries.
Disadvantages of an A-B Trust
We also see three main disadvantages to AB Trusts:
1) Complexity: Setting up and managing an AB trust can be more complex and expensive than a simple revocable living trust.
2) Lack of Access: The surviving spouse has limited access to the assets held in the Family Trust, which may create cash flow issues in certain situations.
3) Ongoing Administration: The Family Trust must be administered and maintained even after the death of the first spouse, potentially incurring additional costs and effort.
High Net Worth Estate Planning and AB Trusts
For high net worth individuals or couples whose combined assets exceed the current federal estate tax exemption, an AB trust can be an invaluable tool in their estate planning strategy. By creating the two-trust structure of a Survivor’s Trust and a Family Trust, these individuals can strategically utilize both spouses’ exemption amounts to their fullest extent.
Through the Family Trust, a substantial portion of the deceased spouse’s assets, up to the exemption limit, can be effectively sheltered from estate taxes upon the subsequent passing of the surviving spouse, thereby reducing the taxable estate of the surviving spouse's estate. This sophisticated approach allows high net worth married couples to preserve a significant portion of their hard-earned wealth for their intended beneficiaries, such as children or future generations, rather than seeing it eroded by excessive taxation.
AB trusts offer high net worth families a way to maximize the benefits of the federal estate tax exemption, ensuring that more of their assets can be passed on to their loved ones according to their wishes.
Effect of New Tax Laws on AB Trusts
The passage of recent tax legislation, such as the Tax Cuts and Jobs Act of 2017, has brought about significant increases to the federal estate tax exemption amount. With the current exemption level set at a substantial $12.92 million per individual for 2023, some may question whether traditional estate planning strategies like AB trusts are still necessary.
However, many experienced estate planning attorneys continue to advocate for the use of AB trusts, even in the current tax landscape. While the high exemption amount may negate the immediate need for tax mitigation for some families, these trusts offer a range of additional benefits beyond just potential tax savings.
Firstly, the exemption levels are subject to periodic review and adjustment by Congress, and future changes to tax laws could dramatically impact the exemption thresholds. Establishing an AB trust now can help insulate families from the effects of potential reductions in the exemption down the road.
Moreover, these trusts provide valuable asset protection, control over the distribution of assets to beneficiaries, and can be particularly advantageous in blended family situations. As such, AB trusts remain a versatile and prudent component of a comprehensive estate plan, safeguarding families' legacies regardless of fluctuations in tax policy.
Talk to an estate and trust attorney today!
Estate planning is a complex and highly personalized process. If you're considering an AB trust or any other estate planning strategy, it's crucial to consult with an experienced estate and trust attorney in Arizona. They can evaluate your unique circumstances, goals, and assets, and guide you toward the most appropriate and effective solutions for your family.
Call Citadel Law Firm PLLC today to schedule your free estate planning consultation. Call (480) 565-8020 or click here to schedule your free consultation. Our estate and trust attorneys will be pleased to help.
Commonly Asked Questions about AB Trusts
What is the Difference between a Marital Trust and a Bypass trust?
In an AB trust, the Survivor’s Trust (Trust A) is often referred to as the Marital Trust, as it holds assets intended for the surviving spouse’s benefit. The Family Trust or Bypass Trust (Trust B) is designed to bypass the surviving spouse’s estate and pass assets directly to the beneficiaries, typically the children or other designated heirs, while utilizing the deceased spouse's estate tax exemption.
Why are AB Trusts not obsolete?
While the increased federal estate tax exemption has reduced the immediate need for AB trusts for many individuals, these trusts still offer valuable benefits beyond just tax savings. They provide asset protection, control over asset distribution, and the potential to minimize future estate taxes if exemption amounts change or assets appreciate significantly.
Is an AB Trust a good instrument for Blended families?
AB trusts can be particularly useful for blended families, where there may be concerns about ensuring fair distribution of assets among children from previous relationships. The Family Trust allows the decedent to specify how and when their assets will be distributed to their respective beneficiaries, providing greater control and clarity over inheritance matters.