A-B Trusts have, historically, been utilized to reduce or negate federal estate tax (f.e.t.) in larger estates. However, since the increase in the exemption relating to f.e.t. over the past few years, the A-B Trusts has been utilized less frequently. This year, 2018, the exemption for an individual is $11 Million. As a result, A-B Trusts would provide protection of $22 Million for couples. Thus, only a small percentage of taxpayers require an A-B Trust in their estate plans regarding f.e.t.
There are two situations, however, in which A-B Trusts may still be viable.
1. Blended Families: In order to ensure that one-half of the community property estate and the separate property estate is received by a spouse’s own children, the A-B Trust may be necessary.
Without an A-B Trust, on the death of the first spouse, the surviving spouse usually owns all of the community property. This fact would allow the surviving spouse to leave all of such property to his/her own children. This action would create a disinheritance of the children of the first deceased spouse. If, however, an A-B Trust was in place, one-half (½) of the community property would be placed in the decedent spouse’s Trust B and the other half in the surviving spouse’s Trust A. Some access to Trust B could be arranged in the Trust for distributions of income and/or principal to the surviving spouse. This is a critical subject of discussion by the attorney in the planning process. The objectives would be to provide for the necessities of the surviving spouse and also insuring an inheritance for the children of the first deceased spouse on the death of the surviving spouse.
The major questions will be how much access will be left to the surviving spouse to invade Trust B and who will be the Trustee of Trust B. If the surviving spouse and an adult child of the first deceased spouse are designated as Co-Trustees of Trust B, there could be fireworks which could lead to legal proceedings. This issue MUST be discussed and specifically detailed in the Trust as this is a major area of conflict.
2. Multiple Property Owners: The A-B Trust can also be a proper planning device for couples who own multiple real properties. The issue in this case is property tax reassessment if the children are going to inherit all or some of the properties.
Under California law, we may exclude reassessment on property inherited by children with the following limitations:
1. The principal residence; and
2. Additional $1 Million from each transferor.
If we utilize a properly drafted A-B Trust, we achieve two transferors of property – Trust A and Trust B.
This allows the property owners to transfer the principal residence and $2 Million to their children free from property tax reassessment. This can be a significant strategy for couples with multiple properties and especially for older or reduced life expectancy clients. Anyway, this should become an object of discussion in the planning process, and proper wording in the Trust distribution is critical to obtain these objectives.
What is an A-B Trust and who typically needs one today?
An A-B Trust is a structure within a married couple’s Living Trust that splits into two separate Trusts when the first spouse dies. Trust A holds the surviving spouse’s share; Trust B holds the deceased spouse’s estate. Historically, A-B Trusts were primarily used to maximize the federal estate tax exemption for both spouses. With the current federal estate tax exemption at $15 million per person, most clients don’t need this advanced planning Trust. The structure remains highly relevant, however, for blended families and for couples with multiple, separate real properties.
How does an A-B Trust protect children from a first marriage in a blended family?
Without an A-B Trust, the surviving spouse in a California community property marriage typically inherits full ownership of the community estate when the first spouse dies, and can leave it to anyone including children from a later relationship. An A-B Trust prevents this by placing one half of the community property into Trust B at the first death, where it is held for the deceased spouse’s own children. The surviving spouse can receive income from Trust B, and the Trust can allow access to principal for specified needs, but the underlying assets ultimately pass to the first spouse’s chosen heirs.
What are the risks if the surviving spouse is named sole Trustee of Trust B?
This is one of the most important planning conversations around the A-B Trust structure. If the surviving spouse has unilateral control over Trust B and the beneficiaries are children from the decedent spouse, conflict is predictable. Naming a co-Trustee from the decedent spouse’s family alongside the surviving spouse is one approach, but it requires very specific Trust language about decision-making authority and distribution standards. Vague provisions in this area are exactly what generates litigation. The Trust must address these issues directly.
How can an A-B Trust help with property tax reassessment on multiple California properties?
California law allows a property tax reassessment exclusion for the principal residence and up to $1 million in assessed value per transferor when real estate passes to children. An A-B Trust creates two transferors, the estate of each spouse, which can double the reassessment exclusion available when properties are transferred to the children. For couples with multiple investment properties in a high-value market like San Diego, this can represent a very significant tax benefit preserved across generations.
If our combined estate is well below the federal exemption, is there still a reason to consider an A-B Trust?
For most couples today, the primary reasons to consider an A-B Trust are blended family dynamics and multiple property ownership, not estate tax minimization. If you and your spouse have children from prior relationships or own several pieces of real estate, the A-B structure can be a powerful planning tool regardless of your total estate size. Whether it is right for your situation depends on your specific family, your property holdings, and what you are trying to protect.
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