This blog post is very similar to an article I wrote in mid-2014. I have chosen to address this topic again because: a) it is very important; and b) most people are still unaware of the featured 2013 Federal Estate Tax law change and its potentially critical implications.I strongly recommend that people have their estate plans reviewed at least ever 3-5 years, or sooner if any significant personal, familial or financial changes have occurred. Given this major law change and its potentially profound consequences for many married couples who have living trusts, it is important to have your estate plan reviewed sooner rather than later.
Major new Federal Estate Tax legislation was enacted in Jan. 2013. As I warned previously, these newer rules may have transformed your existing living trust into a bomb ticking silently.
This article focuses on married couples who have a type of living trust that was very commonly drafted for decades – generally referred to as a formula “A-B” or “A-B-C” trust.
The bad news: your A-B trust bomb is set to explode when the first spouse dies. During the last three years, I have had to explain to too many widows and widowers why their trust exploded and how I needed to help clean up the damage.
The good news: it’s fairly easy for you to avoid the explosion, and thus the damage; but you must change your A-B trust (assuming it is advisable upon advice from legal counsel) before the first spouse dies.
Prior to Jan. 2013: A-B trusts have been extremely popular for many years, and for good reason. This structure enabled married couples to legally eliminate or minimize Federal Estate Tax liability (with a top tax rate of 55% during much of the last few decades) that would otherwise be imposed upon the death of the surviving spouse – assuming he or she died with more than a certain threshold amount of net assets. This threshold – the amount exempt from Federal Estate Tax liability (“exemption”) – has varied greatly over the years, but was as low as $600,000 through much of the 1990’s. Accordingly, many couples had estates that were vulnerable to this “death” tax.
A-B trusts were designed primarily to mitigate Federal Estate Tax. By segregating the assets into two separate (A & B) sub-trusts after the death of the first spouse, the couple could use two Federal Estate Tax exemptions – one applicable to the deceased spouse’s assets and one applicable to the surviving spouse’s assets.
Alternatively, with a “one pot” trust, in which all of the assets of the first spouse to die and the assets of the surviving spouse remain in one pot, only one exemption (that of the surviving spouse) is available; the exemption of the first spouse to die is lost. So, unless a couple had an A-B trust, the children and/or other loved ones were potentially exposed to tens or hundreds of thousands of dollars in unnecessary Federal Estate Tax liability.
After Dec. 2012: The new law passed in Jan., 2013 was a “game changer”. The exemption is now $5.45 Million, indexed annually for inflation. More importantly, a new feature called “portability” enables married couples to use two full exemptions without splitting the assets into two separate pots (A-B) after the first spouse dies. Consequently, a huge number of married couples no longer need an A-B Trust for Federal Estate Tax reasons!
Nevertheless, you might ask: what is this bomb that’s ticking? What harm is there in just keeping your old A-B trust? Unfortunately, there are substantial, yet not commonly understood, disadvantages of an A-B trust, including these primary ones: a) they are more expensive and inconvenient to administer after the first spouse dies; b) an attorney is generally needed to help the surviving spouse allocate and transfer assets into the respective sub-trusts; c) separate accounts must be maintained for each sub-trust; d) a separate tax return must be prepared and filed for the ‘B’ Trust every year of the surviving spouse’s life; and e) the future sale of certain assets in the ‘B’ sub-trust (that appreciate after the first spouse dies) may trigger income tax that would not have been payable if the assets had been kept in a one pot trust.
Some non-tax reasons may still warrant a two pot trust, particularly for many blended families; however, current strategies other than an A-B trust are often more advantageous. In any event, the newer Federal Estate Tax rules provide a golden opportunity for married couples to seek counsel from an experienced estate planning attorney about the pros and cons of keeping or revising their existing trust structure.
This article is intended to provide information of a general nature, and should not be relied upon as legal, tax, financial and/or business advice. Readers should obtain and rely upon specific advice only from their own qualified professional advisors. This communication is not intended or written to be used, for the purpose of: i) avoiding penalties under the Internal Revenue Code; or ii) promoting, marketing, or recommending to another party any matters addressed herein.
ESTATE PLANNING & TRUST ADMINISTRATION: Need to find an experienced estate & trust administrator in Walnut Creek CA? Contact Robert Silverman at 925-705-4474 for legal advice on a Revocable Living Trust, “Summary” Estate Administration, Trust/Estate Beneficiary Representation and Will & Trust Disputes.