AB Trusts: the Tax-saver

To maximize their federal estate tax exemption, married couples create an AB trust. Contrary to popular belief that AB trusts are only beneficial to those with large assets, this kind of trust is also beneficial to anyone who may owe estate taxes.

How the AB trust system works?

If a spouse leaves their properties through their last will and testament, the estate will be charged with taxes prior to the receipt of the beneficiaries. To avoid this, spouses may consider setting up an AB trust which names the beneficiaries, which are usually the children, to receive the decedent spouse’s properties. In which case, the trust is for the benefit of the children, and therefore the surviving spouse technically does not owe the properties. However, the surviving spouse may still be allowed use the properties in the trust, or even spend the principal. When the surviving spouse dies, all the rights and benefits of the irrevocable trust will be transferred to the surviving beneficiaries. And since the latter spouse does not own the properties in the trust, it is not subject to estate tax. The AB trust is a setup that allows for a portion of the surviving spouse’s estate to be free from estate tax.

If a joint trust has $4,000,000 in assets and the husband dies, all the property will be left to his wife. Since there is no estate tax on transfers between spouses, the wife will get all of the $4,000,000. When the wife dies and everything is left to their child, only half of the joint trust is exempt from tax, therefore leaving the child with a $2,000,000 that is subject to a large tax.

But if the husband and wife created an AB trust of $4,000,000 before the husband died, then the trust is divided and the husband’s share of $2,000,000 is put in Trust A, and the wife’s in Trust B. The wife cannot sell any property that is in Trust A, but can use it and keep all the income and interest from it. She will also be able to do whatever she wants with Trust B. When she dies, the trust property is distributed to the child. Because the husband’s share was not transferred to the wife, but to the AB trust, then his $2,000,000 is still tax exempt, and this amount is transferred to the child tax-free. Just the same, the wife is eligible for an exemption for her $2,000,000 and is also transferred to the child tax-free. All in all, the child receives the $4,000,000 through the joint trust.

The surviving spouse does have rights over the assets

The AB contains a condition the will benefit the surviving spouse, wherein the surviving spouse may exercise some limited power over the assets in the trust. The rights of the surviving spouse depend on what is written on the trust, with its language complying with the limits set by the IRS. If in case a trust grants more power to the surviving spouse than what the IRS would allow, then the surviving spouse illegally owns the property of the trust.

The surviving spouse has the right to receive the income and interests from all the properties in the trust. They may also use the properties, and take from it amounts that will be used for their own healthcare, maintenance, support, education and standard of living. These rights remain until their death. The properties are distributed to the beneficiaries of the original trust upon the death of the surviving spouse, and all of the latter’s property are distributed to their beneficiaries.

There are some disadvantages of establishing an AB trust

One must keep in mind that an AB trust is irrevocable. When one spouse dies, no changes can be made to the trust. At times, this may cause some conflict between the surviving spouse and the named beneficiaries of the trust.

The settlement and distribution of properties in an AB trust could be expensive and the help of professionals such as lawyers and accountants are usually needed in order to determine the best way to distribute a couple’s assets between the irrevocable trust and the surviving spouse’s living trust. There are tax consequences to consider when distributing property. Trained professionals who are expert in this area will be able to guide you through the process of figuring out how to go about the distribution while minimizing taxes.

There is also a lot of paperwork and bookkeeping involved in keeping an AB trust. The surviving spouse needs to keep all the records of all the properties in the AB trust. They also need to get the tax ID number of the irrevocable trust and annually file for the income tax return of this trust.

Despite all the work involved, and AB trust could save you money in estate taxes. Weigh the pros and cons of setting up an AB trust to know if it is what’s best for you and your family.

How to tell if an AB trust is right for you?

AB trusts are not for everyone. It is more advisable for married couples over the age of 60 and do not have children from previous marriages. For younger spouses, having your property restricted for the rest of your life could be burdensome upon the death of one spouse. If there are children from previous marriages, there may be conflict between the surviving spouse and the decedent’s children on the sharing of the assets.

To find out if an AB trust is right for you, consult with an attorney for more information and advice tailored to your specific circumstances.

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