Understanding what exactly a Simple Revocable Trust is, and how it works, is confusing enough for most people. But the A/B Trust can really throw one for a loop. So what exactly is an A/B Trust and how do you navigate its complexities?
The A/B Trust for Tax Purposes
In prior decades, the federal estate tax limit was low enough that when a substantial number of people died, their assets would be taxed by the federal government before going to their beneficiaries. To get around that tax, Estate attorneys recommended more complex trusts, commonly called “A/B” Trusts for married couples. The set up was such that upon the death of the first spouse, the trust would split, and a part of it would become irrevocable. Being “irrevocable” would allow the assets in that part of the trust to essentially avoid the federal estate tax. Naturally there are lots of legal caveats and complexities to this, but this is the general idea.
Today the Federal Estate tax is such that, unless a married couple has over ~ $22 million in assets, there is no need to do an A/B trust. In fact, in many cases, if someone dies with an A/B trust now, they could be at a financial disadvantage due to capital gains taxes. If they can, couples who currently have an A/B Trust that was done many years ago should strongly consider doing a new Trust.
For many people it is too late to do a new trust, and their beneficiaries will be forced to manage the complexities of an A/B Trust. Lately it’s been a big topic of conversation in our firm as we currently have multiple trust administrations and trust litigation matters with A/B Trusts executed many years ago.
The A/B Trust for Blended Families and Separate Property
Couples who have considerable separate property assets and/or children from different marriages may also strongly consider doing an A/B Trust. Aside from the tax benefits it can offer, an A/B Trust also protects the distribution of assets after the death of the first spouse.
1. If you’re a couple and have less than approximately $22 million in combined assets, an A/B Trust is no longer necessary to avoid Federal Estate Taxes. In fact, it may actually trigger additional taxes if you have one.
2. If you have a blended family or considerable separate property assets you may wish to have an A/B Trust to prevent the distribution of assets from being changed after your death.
3. If you are the Successor Trustee to an A/B Trust and are tasked with job of administering the Trust and distributing its assets, consult an attorney to ensure the correct division and distribution of its assets.
Into the Weeds – Components of an A/B Trust: “Sub-Trusts”
The common components of the A/B Trust are, simply put, Part A and Part B. Part B becomes irrevocable upon the death of the first spouse. “Irrevocable” means it cannot be changed. Therefore Part B is set in stone, so to speak. Part A remains revocable after the death of the first spouse. In other words, Part A can still be revoked or changed by the surviving spouse. When the last spouse dies, both parts of the trust will become irrevocable. The fact that Part B can no longer be changed limits the flexibility of the living spouse (for better or worse) and also has tax implications which can be undesirable in some circumstances.
Now, keep in mind that in the actual trust document, Part A and Part B will likely not be called as such. Instead they will have names such as “Survivor’s Trust,” “Bypass Trust,”“Non-Marital Trust,” “Marital Trust,” or “Disclaimer Trust,” among others. These are known as different types of “Sub-Trusts,” which brings us to the next question:
What is a Sub-Trust?
A Sub Trust is a Trust within a trust. Generally the sub trust does not become an actual Trust until certain conditions are met. Often that condition is death. In the majority of A/B Trusts, one single Trust exists during the lifetime of both spouses. For example, Bob and Jane Smith create an A/B Trust called the “Smith Family Trust.” While they are both alive there is only one Trust. However, the “Smith Family Trust” contains sub-trusts that will come into existence upon the occurrence of a particular event. The crucial event in an A/B Trust is generally the death of the first spouse.
A typical sub trust that would become effective as of the death of the first spouse is often called the “Survivor’s Trust.” The Survivor’s Trust holds certain assets for the spouse that “survives” the other. Typically the Survivor’s Trust is revocable – in other words, it can be changed by the surviving spouse. The assets contained in the Survivor’s Trust are spelled out by the trust document. For the remainder of the assets, sub trusts such as the “Decedent’s Trust”, “Bypass Trust,” and “Disclaimer Trust” (among others) are typically found in an A/B Trust. Often, one or more of those trusts will be irrevocable after the death of the first spouse. This means that the surviving spouse cannot change those trusts or revoke them.
Once both spouses pass away, the named Successor Trustee will be tasked with the job of dividing up the assets according to the terms set forth in the various sub trusts. If all the sub trusts have the same beneficiaries, this may not be necessary. Unfortunately this is not always the situation.
In many cases, the assets will not have been separated or split into the various sub trusts when the first spouse died. So, the Trustee will need to divide the assets among the trusts as if they had been divided up previously. This can get confusing, especially if one is trying to divide up a house and determine its value as of the date of death of the first spouse.
What’s the bottom line here?
If you’re the Successor Trustee of a Trust that contains multiple sub-trusts with different beneficiaries, consult with an experienced Trust & Estate attorney. As a Trustee, you have a legal duty to the beneficiaries and you’ll want to be especially careful to protect yourself when administering a complex trust.
If you have an outdated A/B Trust, consult with an Estate Planning attorney to determine if you need to have it updated.
And, for those couples who have children from previous marriages or want to name different beneficiaries while still having a Trust together, consult with a Trust and Estate lawyer to see if an A/B Trust could benefit you.
If you have questions about Survivor’s Trusts, Bypass Trusts, Sub-Trusts, or Revocable Trusts, contact our SF East Bay Trust and Estate Team at 925-322-1795.
I’d also like to add to this rather perceptive article another type of “Family Trust”, that happens to be growing in popularity throughout California, with middle class homeowners — helping middle class families save on taxes as inflation hikes up prices of goods due to Pandemic related issues impacting all sorts of product distribution all across the state, and the entire country, actually… We’re talking about an irrevocable trust frequently used in conjunction with Proposition 19 (formerly with Proposition 58 before the realtor community did us the big favor of squashing Prop 58) to buyout co-beneficiaries who have inherited the same home from a Mom or Dad… protected by Proposition 19 & Prop 13, allowing you to transfer parents property taxes, basically inheriting property taxes so you can keep parents property taxes more or less forever, locking in a nice low property tax base through the popular parent-to-child exclusion. Also being able to squash conflicts arising from heirs wanting to keep a home inherited from parents versus siblings insisting on selling their share of inherited property. So beneficiaries wanting to keep their inherited property can buyout sibling looking to sell, through a loan to an irrevocable trust — a sibling-to-sibling property transfer — with the invaluable help of an established California trust lender. In short, avoiding property tax reassessment while siblings selling their property shares get far more through trust loan funding than from selling out to an outside buyer with a realtor involved, charging their 6% commission, pricey legal fees, often fixer-upper costs; etc. An excellent suggestion — for info on all this, for the uninitiated, definitely go to the CA State Board of Equalization at https://www.boe.ca.gov or a property tax blog like https://propertytaxnews.org or maybe a trust fund lender like https://cloanc.com for info on trust loans, trusts and estate funding. Bottom line, the more we know the better off we’ll be when a complicated inheritance situation arises that requires the right knowledge, knowing who to go to for the right info and safe parent-to-child exclusion; to save thousands per year on taxes, looking up ahead.