The federal estate tax exemption has increased significantly over the last two decades and is now increasing each year in relation to inflation. For 2016, the exemption is at an unprecedented $5,450,000.00 per decedent. This means a couple can pass on $10,900,000.00 worth of assets to their beneficiaries without any estate tax being paid. Since 2011, a surviving spouse has been able to “port” a deceased spouse’s unused exemption to their exemption, thus allowing a spouse to preserve the deceased spouse’s exemption without funding Trust B.
The high exemption, portability, and strategic estate planning allow 99% of families to be exempt from paying any estate tax. Because of this it may be time for you to reconsider keeping your A-B Trust or replacing it with a simple non A-B Trust.
In general an A-B Trust requires a surviving spouse to allocate the deceased spouse’s interest in the community property, as well as the decedent’s separate property, to an irrevocable Trust B. Most trusts allow for a surviving spouse to receive income from Trust B assets for their health, education, and support. A benefit of funding Trust B is that any assets held in Trust B can be protected from lawsuits if the surviving spouse gets sued. Because Trust B is irrevocable, assets held in Trust B may only be distributed as the deceased Trustor indicated. If a surviving spouse remarries, the surviving spouse cannot change the distribution of Trust B to allow for the new spouse to receive the assets. If you have multiple properties with high assessed values, allocating assets to Trust B preserves the deceased spouse’s $1 million exclusion from reassessment for transfers of California real estate from parents to children.
While there are multiple reasons to allocate assets to Trust B, there are also many reasons a not to. Because Trust B is an irrevocable trust with its own tax identification number, tax returns must be filed for Trust B. The tax rates for irrevocable trusts are often higher than those of an individual, but Trust B does have a small 15% tax rate under certain circumstances. Another disadvantage is that assets in Trust B are not included in the taxable estate of the second spouse to die so they do not get a step-up in basis at the second spouse’s death. No step-up in basis can cost remainder beneficiaries a lot more in capital gain income tax when inherited assets are sold.
We are happy to discuss the additional benefits and disadvantages of the A-B Trust with you. If you believe it may be time to simplify your A-B Trust, please contact our office to schedule a time to meet with us. Please note that if you are a surviving spouse who has already funded Trust B, it may be possible to petition the court to allow you to eliminate Trust B.