If you’ve reached this area of our website, you either know you have an AB Trust or aren’t sure. Either way, you’re here to get the answer on whether or not an AB Trust is right for you. The good news is as long as you have any kind of trust, your estate will avoid probate after you, the settlor, or owner of the trust, pass away.
II. WHAT ARE AB TRUSTS & WHY WERE THEY SO POPULAR?
AB Trusts are popular for estates that are over the federal estate tax threshold. A decedent’s estate is exempt from federal estate tax up to the constantly changing threshold; in 2022 that number was $12.06 million. See our updated Federal Estate Tax Table. This means the federal government can tax up to 40% of all value above that line. For example, if a decedent passed away in 2022 and the estate is worth $20M, the first $12.06M is exempt from federal estate taxes, but the government will take up to 40% of the exceeding $7.94M. Most of us don’t fall into this category and you’re probably wondering why you have an AB Trust when your estate is worth far below that. This is because the tax threshold was probably much lower when your trust was made and increased incrementally during the late 90’s and into the 2000’s. Before 2000, the exemption was only $600,000, and in California, it was easy for an estate to exceed that amount, subjecting many to federal and state taxes. Refer to the updated Federal Estate Tax Table to see how the amount has increased over the decades.
III. HOW DO THEY WORK?
We’ve covered that AB Trusts allow your estate to avoid federal estate tax, but how do they work? First, they are used for married couples, so if you are single an AB Trust does not apply. It’s easiest to think of an AB Trust as two separate trusts, one for each spouse, that are temporarily conjoined. Usually, the settlors, as a married couple, move joint or separate property into their trust throughout their lives together. Upon the death of the first spouse, the trusts split into two, an A and a B. The assets split as well, and all joint property is divided in half; meaning each trust has 50% ownership of each joint asset in the schedule. Each trust contains their own separate property as well. The trust of the decedent is then locked out and cannot be altered by the surviving spouse. However, the surviving spouse can alter their individual trust, and do as they please with their individual assets. While this is straightforward for claiming 50% of your shared stock, allowing you to sell as you please, this can get confusing for things you cannot sell 50% of, like a house, as proper steps need to be taken. Further, if the decedent has passive income entering their trust annually (from stock or rental properties), the surviving spouse will be required to submit a tax return for the decedent’s estate annually. This is considered a ‘trustee duty’, yet the full trust administration and disbursements normally take place after both settlors pass away. At the death of each spouse, estate taxes are then avoided (or brought down) because each trust usually only has 50% of all assets in them. Going back to the sample $20M estate; with a simple probate avoidance trust, they would be taxed up to 40% of $7.94M at the second death (setting aside “portability” options.) With an AB Trust, however, each trust only has a $10M estate, meaning they are both exempt from federal estate taxes.
IV. UNDUE INFLUENCE: ANOTHER REASON FOR AN AB TYPE TRUST
However, Estate tax avoidance is not the only reason settlors opt for an AB type Trust. The second reason is to protect your own beneficiaries and avoid undue influence on the surviving spouse from outside parties. This may sound like a move inspired by ill-faith towards your partner but is no less common than a prenuptial agreement. This can be particularly useful for blended families, allowing each spouse to ensure their respective heirs are left with something. Regular probate avoidance trusts are commonly set to have no disbursements on death of the first spouse as well, but the surviving spouse then becomes the sole trustee and “owner” of the entire estate. They are free to amend the document as much as they like, writing in or out beneficiaries. Once again, this is unlike the AB Trust which locks out the decedent’s trust making it impossible for the surviving spouse to amend.
V. SHOULD WE CHANGE FROM AN AB TO SIMPLE PROBATE AVOIDANCE?
If your estate falls below the federal tax exemption it could be a good idea to switch to a simple probate avoidance trust. In a situation where you are the surviving spouse of an AB Trust it could mean more work and money from filing tax returns on the decedent’s estate. Further it means complications if you would want to sell your real property, or other expensive personal property items. On the other hand, if your estate is lower than the threshold amount but you are attracted to the undue influence protection of an AB Trust (especially if one spouse has considerable separate property) there are similar yet easier to administer estate plans that we can get you and your spouse set up with. For instance, in a blended family situation, in the past we have sent clients home with a three-trust portfolio: a trust for each spouse and a trust for the family. This accomplishes the security for your beneficiaries since your partner will be unable to amend your personal trust after you pass away.
All of our existing and potential clients have unique situations, and while I hope this article was helpful, you may still have some more questions. Please email or call our office to set up a consultation where we can properly evaluate your situation and come up with a game plan that best fits you, your family, and your estate.
This article was written by Vittoria Rainone, a part time para legal at our law firm and second year law student at UC Hastings, San Francisco. The colloquial tone is an attempt to simplify a complex and confusing topic for clients and prospective clients. While none of our articles constitute “legal advice” it was reviewed and approved by practicing attorney.