Bypass Estate Tax: Consider an AB Trust

Originally published by Axel Lindholm.

For individuals with a large estate, the prospect of estate tax is a constant threat. No one wants to see the money and assets that they have worked so hard to achieve reduced significantly by the threat of tax. One way to circumvent the application of the estate tax is an AB trust.

Utilizing AB Trusts for High Wealth Estates

AB trusts are used less frequently now than they were prior to 2011. Under existing laws, every individual has a $5.49 million dollar exemption to the estate tax. This means that more than 5 million dollars can be transferred from an individual’s estate before tax is imposed. Prior to 2011, this exemption applied individually to each spouse in a marriage, and could not be combined.

For example, assume a couple each owns 5 million dollars in assets.  When the wife dies, her half of the estate (5 million) passes to her husband, who now owns all 10 million in assets individually. When he passes away and his estate is passed on to his children, they will owe estate tax because his estate is worth more than 5.49 million dollars.

In 2011, the laws were changed to allow marital spouses to combine their exemptions for use by either individual. So in total, the spouses can claim almost 11 million dollars in exemptions. If, as in the above example, the wife dies and gives her 5 million dollars in assets to her husband, her husband’s 10 million dollar estate would be exempt from the tax because he could claim the 5.49 million dollar exemption for both of them.

This change in the law has made AB trusts less necessary, but still an important vehicle for high-wealth couples.

How do AB Trusts Work?

When a spouse dies, an AB trust allows his or her assets to be transferred to an irrevocable trust, rather than directly to the other spouse. The beneficiary spouse of the trust may receive income from the trust, and may sometimes even access the principal of the trust. However, because it is in a trust, when the beneficiary spouse eventually passes away, the trust is not considered part of his or her estate and is not considered for estate tax purposes.

When couples intend to pass the totality of their estate on to their children (or another individual) upon both of their deaths, AB trusts can be a way of ensuring that the spouses benefit from their estate while still alive, but do not face tax consequences after death. This is particularly important for spouses whose cumulative wealth is in excess of the 11 million dollar combined exemption.

AB trusts serve the additional purpose of protecting trust property from creditors and divorces. If the surviving spouse is sued or divorces, the AB trust protects the trust property and ensures the property remains in the first to die spouse’s bloodline.

Who Can Benefit From an AB Trust

Because of the large cumulative exemption now available to couples under the law, many may no longer need to utilize an AB trust in order to avoid estate tax. However certain individuals can still benefit, including:

• Those with very large estates
• Those with possible blended family scenarios
• Couples who are not legally married (the exemption applies only to those who are)
• Individuals who live in states with state estate taxes that they also wish to avoid

Discuss Your Future Plans With the Tax Experts at Romano & Sumner, PLLC

At Romano & Sumner, PLLC, our tax attorneys can help you evaluate whether your estate is at risk of an estate tax and, if so, how to structure your assets to avoid this tax. To discuss how best to find out your company’s worth, contact us online or at 281-242-0995.

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