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How to Use an AB Trust to Minimize Estate Tax Obligations

For married couples who own a substantial amount of wealth, the federal estate tax threshold is double the limit applied to individuals. In other words, these couples can pass on up to $10.98 million before the estate tax kicks in.

However, couples whose wealth exceeds that limit will need to work with an estate planning attorney to develop what’s known as an AB trust to reduce their tax obligations.

How do AB trusts work?

Under current tax law, each spouse has his or her own estate tax exemption. The first spouse to pass away typically does not use that exemption, as most spouses leave everything to the surviving spouse. However, that may cause some complications. The surviving spouse would own everything, which could potentially put him or her over the individual estate tax exemption amount—whereas they would have previously been under the exemption amount while the spouse was still alive.

To resolve this problem, individuals should work with an estate planning lawyer to create an AB trust. Instead of spouses leaving their property to each other, they each provide it to an irrevocable trust. The surviving spouse receives any income the trust generates, and may also have access to the principal. In most circumstances, the children then inherit that property after the death of the second spouse.

Irrevocable trusts are non-taxable because the assets contained in them is technically no longer owned by either spouse. Therefore, children can inherit that property tax-free after the second spouse dies without having to worry about that property going through probate.

Other situations in which AB trusts are useful

Most couples will not need to use an AB trust, as only a small percentage have estates valued at more than the joint exemption limit. But there are several other situations in which an AB trust serves as a valuable estate planning tool. These include the following:

  •      Relationships in which there is a concern that the surviving partner may be subject to undue influence, fraud, or manipulation. Drafted properly, an AB trust can effectively provide asset protection for the assets in the irrevocable trust.
  •      You wish to ensure your children receive your property. An AB trust is particularly useful for people in second marriages. The surviving spouse can still use your property, but after his or her death, it will transfer to your kids.
  •      You owe state estate tax. Some states have their own taxes on estates in addition to the federal estate tax, typically with lower exemptions and no portability. An AB trust can lessen your state tax liability.

There are some drawbacks to AB taxes. There are restrictions on the use of the property for the surviving spouse, as that property is in an irrevocable trust. The trusts can be expensive to manage, and you must deal with tax returns for them. But in many situations, they can be a valuable tool to lessen the tax impact on your estate planning in California.

Schedule Your Consultation with Our Experienced California Estate Planning Attorneys

Bartlett & Herrington, P.C. is a top estate planning law firm in Carpinteria, California. Our attorneys help families set up living trusts, wills, power of attorneys, healthcare directives in Santa Barbara, Ventura and Montecito. We also serve clients in probate, elder law, Medi-Cal planning, retirement planning, asset protection, and Veterans Affairs (VA) aid and attendance planning.

Schedule a planning session with our experienced attorneys today to learn how we can help you and your family: (805) 576-7693.

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