- Privacy Policy For thismatter.com
- Information is provided 'as is' and solely for education, not for trading purposes or professional advice.
- Copyright © 2005 - 2011 by William C. Spaulding
The AB living trust (aka bypass trust, family trust) has a number of benefits for a married couple that allows both spouses to use the full amount of their federal estate tax exemption, while allowing the first-to-die spouse to provide support for his spouse while maintaining control over the ultimate disposition of his property. The federal estate tax exemption is the amount that is not subject to federal estate tax, which, for 2011 - 2012, is $5,000,000.
Consider the possibilities of the couple with property worth more than the estate tax exemption but less than twice the tax exemption. Without the use of a trust, the deceased spouse can leave all of his property to either:
Consider a couple where each spouse has $1 million worth of property and the federal estate tax exemption is $1 million. The couple intends to leave all of their property to their children and the husband is the 1st to die.
Scenario 1: The husband leaves all of his property to his wife. No estate tax is due because of the unlimited marital deduction. However, when the wife dies, her estate will be worth $2 million, but only her tax exemption of $1 million can be applied to the property. Therefore, estate tax will be due on the $1 million above the wife's tax exemption, leaving less for their children. Net result: Support is provided for the wife during her lifetime, but the children ultimately pay estate tax on $1 million of their mother's estate.
Scenario 2: The husband leaves all of his property to their children. No estate tax is due because the children benefit from their father's tax exemption. However, no support is provided to the surviving spouse. But when the surviving spouse dies, then the children can inherit the $1 million of their mother's estate also free of estate tax. Net result: The children inherit $2,000,000 free of estate tax, but no support was provided to the surviving spouse.
The AB trust is predicated on several principles:
The surviving spouse's right to spent principal is restricted because if it wasn't, then the IRS would consider the trust principal to be her money and would be includable in her estate when she dies, thereby losing the deceased spouse's tax exemption on the trust property.
The health, education, support, and maintenance standard is what the IRS calls an ascertainable standard, meaning it must be measurable. Any amount of principal can be spent according to the ascertainable standard. The amount spent for support and maintenance is usually the amount necessary to support the surviving spouse as she was accustomed to living.
The advantage of the 5 or 5 power is that the trust principal can be spent for any reason and can be spent for specified beneficiaries other than the surviving spouse. However, if the surviving spouse lives long enough, then she could spend the entire amount in the trust, leaving little or nothing for the deceased spouse's beneficiaries.
Since one of the benefits of the AB trust is that it prevents the surviving spouse from changing the beneficiaries of the deceased spouse's trust, which is useful if the deceased spouse has beneficiaries that the surviving spouse might not favor, such as children from a previous marriage, then it may make sense to restrict the spending of principal so that there will be at least a certain amount left; otherwise, the benefit of not being able to change the beneficiaries of the trust may become moot, if there is nothing left to distribute. If a spouse wants to be sure that his beneficiaries will receive all of the trust principal, then the trust document can forbid any spending of principal by the surviving spouse for any reason or allow only a set amount of trust principal to be spent, so that the beneficiaries will receive at least a certain amount.
The AB trust is only tax advantageous for couples that are legally married under federal law — same-sex unions or marriages are not recognized, even if they are recognized by the state. However, common-law marriages are recognized, even if the couple moves to another state that that does not have a common-law statute.
There are several types of couples who would probably not want to use may an AB trust. Younger couples, for instance, because if one spouse dies prematurely, the other spouse is likely to live for many years afterward and would have to manage the trust for the duration. The same problem would occur if one of the spouses is much younger than the other. If each spouse is independently wealthy, then the surviving spouse would probably not need support, allowing the deceased spouse to leave his property directly to his beneficiaries.
The standard AB trust usually begins as a shared marital trust. When the 1st spouse dies, the marital trust is divided into 2 trusts: Trust A and Trust B. Trust A receives the property of the deceased spouse, but with the surviving spouse named as life beneficiary of the trust while the principle is held in Trust A for the deceased spouse's beneficiaries. The surviving spouse can receive all income from Trust A, and can also receive some principal. With a standard AB trust, when the surviving spouse dies, then the principal of Trust A goes to the beneficiaries of the 1st spouse to die. The property of Trust B goes to the beneficiaries of the surviving spouse. Because the trusts are separate, each spouse can use their estate tax exemption for their trust, so that if the value of the property is less than the exemption in each trust, then there is no federal estate tax on the property.
The reason why the surviving spouse's rights to Trust A is restricted is because if there were no restrictions, then the Internal Revenue Service (IRS) would treat the property in Trust A as the property of the surviving spouse, since she would be using it as if it were her own property — hence, the IRS would include the property in Trust A as belonging to the surviving spouse, and, thus, only her estate tax exemption would be available. Because the surviving spouse has only a life estate interest in the property in Trust A, the principal in Trust A it is not entitled to the marital deduction — hence the federal estate exemption amount applies to the property in the trust.
Without using an AB trust, the couple could leave their property to their children as each dies, which would take advantage of the double federal tax exemption, but then it would limit the amount available to the surviving spouse. Of course, the deceased spouse can transfer all of his property to the surviving spouse and take advantage of the unlimited marital deduction, but then when the surviving spouse dies, she can only use her tax exemption. The tax exemption of the predeceased spouse would be lost.
Furthermore, since Trust A becomes irrevocable when it is created, the surviving spouse cannot change the beneficiaries. Other benefits of the AB trust is that assets in Trust A can appreciate free of estate taxes. It can also protect assets if the surviving spouse suffers a catastrophic illness or other financial calamity.
A variation of the standard AB trust is the AB disclaimer trust, which allows the surviving spouse to disclaim any property that is to go into Trust A. A disclaimer is a written declaration by a beneficiary that she declines to accept property left to her, causing the property to go to an alternate beneficiary, which, in this case, is Trust A.
With a disclaimer trust, the surviving spouse can decide how much property she wants to keep for her own benefit or to maximize tax savings. Whatever she disclaims goes into Trust A.
The drawback to the AB disclaimer trust is that if the surviving spouse does not disclaim any property, then there will be nothing in Trust A for the deceased spouse's beneficiaries. However, this would not be a problem if the couple is just going to leave their property to their children.
The main benefit of the AB disclaimer trust over the standard AB trust is that the surviving spouse can maximize tax savings, which will depend on the tax law when the 1st spouse dies. For instance, if the 1st spouse died in 2010, when the estate tax was repealed for 1 year, then the surviving spouse could disclaim all of the deceased spouse's property.
A sprinkling AB trust can also be created that would allow the surviving spouse to use some of the principal in the trust to pay its beneficiaries before the surviving spouse dies, if they need the money sooner. However, the surviving spouse cannot be the trustee; otherwise, the IRS will include the trust property in the surviving spouse's estate and the exemption for the deceased spouse will be lost, thereby negating the tax benefit of the AB trust.
If the surviving spouse is the trustee of Trust A, then she will have a few duties to perform when her spouse dies. When a standard AB trust is created, the surviving spouse must divide trust property into the respective trusts — new title documents must be prepared and the surviving spouse must obtain a taxpayer ID number for Trust A, maintain accurate financial records, and file an annual income tax return for Trust A. Usually an estate lawyer or accountant will be needed to determine how to best to divide the couple's assets into the 2 trusts.
Records must be kept describing how the surviving spouse is using the property in Trust A. Administrative expenses must be paid. The surviving spouse must also keep 2 sets of books and records — one for her own property and one for Trust A property.
One problem with AB trusts is that there could be a potential conflict of interest between the surviving spouse and the beneficiaries of the trust, especially if the surviving spouse invades the principal for health, education, support, or maintenance, which could consume a considerable amount of principal or even all of it, leaving nothing for the beneficiaries. Conflict could also arise if the surviving spouse becomes incapacitated, and one of the beneficiaries assumes control as trustee, since the beneficiary may be more interested in preserving principal than providing support for the surviving spouse who is nearing the end of her life.