THE “TAX AVOIDING” A-B TRUST

The federal government has given every American citizen a one million dollar exemption from the federal estate tax, so if you, or if you and your spouse combined own less than one million dollars in assets, then using an A B Trust will not save you any estate taxes, because you are already exempt.

But if the value of a married couple’s estate exceeds one million dollars, an A B Trust can be used to pass a combined estate of up to $2,000,000.00 to their children free and clear of any federal estate tax. The reason for this is that the Husband and the Wife each have a one million dollar exemption, but they will automatically lose one of those exemptions unless they use an A B living trust.

Here is a ridiculously simple example of how one of the spouse’s exemption is lost without the use of an A/B Trust:

  • Husband has a $750,000.00 life insurance policy naming Wife as beneficiary.
  • The couple jointly own a $750,000.00 house.
  • Husband dies, and Wife is paid $750,000.00 from the insurance company. She now solely owns the house, because she and Husband jointly owned the house.
    Wife’s estate is now valued at $1,500,000.00.
  • Wife dies. Since her estate exceeds the one million dollar exemption by $500,000.00, the difference ($500,000.00) will be taxed at no less than 37% before her beneficiaries can receive ownership.

That is $185,000.00 that could have passed to their beneficiaries, free and clear of the estate tax, had they created an A B Trust!

EXAMPLE OF AN A-B TRUST WITH TAX SAVINGS PROPERTIES

Example 03

Here’s how an A B Trust uses each spouses exemption to avoid the federal estate tax.

While both parties are living, they create a revocable living trust as outlined in my first example.

At the time the Trust documents are created, rules or conditions are added providing that when the first spouse dies, the survivor (who is then acting as the Trustee (or Manager) will divide the property from their first Trust into two separate trusts – Trust “A” which will remain a revocable trust for the use and benefit of the surviving spouse; and Trust “B” which will be an irrevocable trust, to ultimately pass on to their heirs after the death of the last spouse. Trust “B” can own up to one million dollars, which is the amount of the deceased spouse’s exemption without losing its exemption to the federal estate tax.

By placing up to $1,000,000.00 into the irrevocable Trust “B”, it has been removed from the couples’ estate and can pass to the heirs, free from the federal estate tax. Since the survivor does not “own” the property in Trust “B”, that portion will not be included in the survivor’s estate for tax purposes. The surviving spouse can also pass up to one million dollars from Trust “A” onto the heirs without paying any estate tax.

And while the surviving spouse does not own the property in Trust “B”, and cannot revoke Trust “B”, they still have the right to:

1. Spend all income earned by Trust “B” in any manner they so desire;

2. Withdraw the greater of $5,000.00 or 5% of the principal of Trust “B” every year to use or spend in any manner they see fit.

3. Spend an unlimited amount of the principal of Trust “B” for health care, education or to maintain their standard of living enjoyed during the marriage.

The restriction on expenditures placed on Trust “B” would not be likely to impact the surviving spouse’s standard of living. Permissible expenditures would include amounts necessary for the “maintenance, health, support or education” of the surviving spouse, such as mortgage payments, purchasing a vehicle, remodeling or maintenance of real estate, or even taking a routine vacation. Prohibited expenses would include buying luxury items, jewelry, collectibles or vacation property. (Trust A would be used for these types of expenditures instead of Trust B).

Keep in mind that Trust “A” retains the surviving spouse’s exemption of one million dollars, and is completely revocable. The surviving spouse can use the property in the A Trust in any manner they desire, and can completely revoke the A Trust, if they wish. They also control, and to a very large extent enjoy and use the property within the B Trust during the rest of their life.

The A B Trust provides that upon the death of the last living spouse, property from Trust “A” and property from Trust “B” will all pass to the couple’s heirs. If the value of Trust “A” is less than $1 million, it will pass free and clear of estate tax. If the value of Trust “B” is less than $1 million, it will also pass free and clear of estate tax. Additionally, there will be no capital gains tax to the heirs AND all of the property in A and in B will escape probate court proceedings.