How Proper Planning Can Save You Thousands in Estate Taxes

By Adil Daudi, Esq.

Unless one of your primary objectives is to fund the government with more of your money, taking the initiative of planning your estate should be one of your top priorities. Far too often people find it an inconvenience to plan their estate; however what is commonly misunderstood is that by taking the time to structure your estate, you could potentially save upwards of thousands of dollars.

One of the optimal tools to use when it comes to estate planning is the creation of a Revocable Living Trust. However, what many attorneys sometimes fail to explain is that even within a Trust, there are certain methods that can be used to help reduce the amount of estate taxes one would normally pay. This trust is commonly referred to as the “AB Trust.”

Under an AB Trust, married couples are given the ability to maximize the use of their federal exemptions from estate taxes. Currently, any estate valued over $5M would be subject to the tax (for the amount in excess of $5M). However, although the current exemption limit is set at $5M, there are strong indications that Congress is to reduce that limit back down to $1M in 2013.

So let’s give a brief breakdown on how an AB Trust works:

How the AB trust system works

In order to avoid being a victim to a steep estate tax, spouses have the option of setting up an AB trust, where each spouse leaves their property to a trust. An AB Trust is created by establishing a living trust with an AB provision. Although the trust remains revocable while both spouses are alive, when the first spouse passes away, the trust becomes irrevocable and is split into two separate components: the A trust and the B trust. Under the A trust, the surviving spouse holds his/her half of the estate, and controls all the property while receiving distributions of income and principle on a need-basis.

On the other hand, the B trust contains the deceased spouse’s share of the estate. Typically, the funds transferred into the B-Trust belong to the beneficiaries, who are usually the children. However, the surviving spouse has the right to use the property during his/her life and is allowed to receive any income, if needed. It is upon the death of the surviving spouse that the property in the B-Trust passes to the beneficiaries designated in the original trust document, as well as the assets contained in the A-Trust.

Advantages of an AB Trust

The property that is contained in the B-Trust is never considered part of the surviving spouse’s estate; therefore it is not subject to estate taxes. It is only the property contained in the A-Trust that is subject to estate taxes at the time of the surviving spouse’s death, but if the A-Trust contains less than the estate tax exemption, then no estate taxes will be imposed. Although many presume an AB Trust is only appropriate if you carry in excess of $5M, which is the current estate tax threshold, this is not necessarily the case because it is always important to note that the current laws may not be the laws in the future. The laws change on a constant basis, and a proper estate plan takes into consideration not just what applies today, but what could apply in the future.

Disadvantages of an AB Trust

With every good comes a little bad. There are disadvantages to an AB trust. After the death of the first spouse, the A and B trusts requires separate tax returns. In addition, the AB trust can limit the surviving spouse’s rights to the trust property, depending on how it is worded.

It is always important to note that an AB Trust is not suitable for every household. With all its benefits, there are reasons for families to not implement such a Trust and to instead utilize the regular Revocable Living Trust. However, it should also be noted that consulting with a professional in the field could prove to be vital as it could potentially save you hundreds, if not thousands of dollars.

Adil Daudi is an Attorney at Joseph, Kroll & Yagalla, P.C., focusing primarily on Asset Protection for Physicians, Physician Contracts, Estate Planning, Business Litigation, Corporate Formations, and Family Law. He can be contacted for any questions related to this article or other areas of law at adil@josephlaw.net or (517) 381-2663.

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